THE BANK OF NEW YORK COMPANY, INC.
Quarterly Report on Form 10-Q
For the quarterly period ended March 31, 2007
The Quarterly Report on Form 10-Q and cross reference index is on page 72.
THE BANK OF NEW YORK COMPANY, INC.
FINANCIAL REVIEW
TABLE OF CONTENTS
Consolidated Financial Highlights 1
Management's Discussion and Analysis of Financial
Condition and Results of Operations
- Overview 3
- First Quarter 2007 Highlights 5
- Consolidated Income Statement Review 6
- Business Segment Review 12
- Critical Accounting Policies 26
- Consolidated Balance Sheet Review 30
- Liquidity 37
- Capital Resources 40
- Trading Activities 42
- Asset/Liability Management 44
- Statistical Information 45
- Supplemental Information 46
- Merger Agreement with Mellon Financial Corporation 48
- Forward-Looking Statements and Risk Factors 48
- Mellon Transaction 49
- Government Monetary Policies and Competition 50
- Website Information 50
Consolidated Financial Statements
- Consolidated Balance Sheets
March 31, 2007 and December 31, 2006 51
- Consolidated Statements of Income
for the Three Months Ended
March 31, 2007, December 31, 2006,
and March 31, 2006 52
- Consolidated Statement of Changes In
Shareholders' Equity for the Three
Months Ended March 31, 2007 53
- Consolidated Statements of Cash Flows
for the Three Months Ended
March 31, 2007 and 2006 54
- Notes to Consolidated Financial Statements 55
Form 10-Q
- Cover 72
- Controls and Procedures 73
- Legal and Regulatory Proceedings 73
- Risk Factors 74
- Unregistered Sales of Equity Securities
and Use of Proceeds 74
- Exhibits 75
- Signature 76
1
THE BANK OF NEW YORK COMPANY, INC.
Consolidated Financial Highlights
(Unaudited)
------------------------------------------------------------------------------------
Quarter ended
--------------------------------------
(dollar amounts in millions, except per March 31, Dec. 31, March 31,
share amounts and unless otherwise noted) 2007 2006 2006
------------------------------------------------------------------------------------
Reported Results:
-----------------
Net income $ 434 $ 1,789 $ 422
Basic EPS 0.58 2.39 0.55
Diluted EPS 0.57 2.36 0.55
Continuing Operations:
----------------------
Key metrics
-----------
Noninterest income $ 1,475 $ 1,441 $ 1,265
Net interest income 427 451 339
-------- -------- --------
Total revenue $ 1,902 $ 1,892 $ 1,604
Total expense 1,272 1,285 1,069
Pre-tax operating margin 34% 33% 33%
Net interest margin 2.18 2.27 1.95
Net interest income on tax
equivalent basis $ 429 $ 452 $ 346
Net income 437 427 360
Basic EPS 0.58 0.57 0.47
Diluted EPS 0.57 0.56 0.47
Performance ratios
------------------
Return on average common equity 15.70% 14.95% 14.75%
Return on average common equity excluding
merger & integration costs 16.06 15.36 14.75
Return on average assets 1.73 1.66 1.50
Return on average assets excluding
merger & integration costs 1.78 1.70 1.50
Return on average tangible common equity 39.20 36.45 27.97
Return on average tangible common equity
excluding merger & integration costs 40.09 37.39 27.97
Return on average tangible assets 1.93 1.87 1.61
Return on average tangible assets
excluding merger & integration costs 1.98 1.92 1.61
Selected average balances
-------------------------
Interest-earning assets $ 79,075 $ 79,841 $ 71,035
Total assets 101,975 102,138 91,831
Interest-bearing deposits 43,862 44,344 41,263
Noninterest-bearing deposits 14,903 14,721 10,119
Shareholders' equity 11,277 11,340 9,888
Employees 23,134 22,961 19,989
Credit loss provision and net charge-offs
-----------------------------------------
Total provision $ (15) $ (15) $ -
Total net (charge-offs)/recoveries 3 (24) 4
Loans
-----
Allowance for loan losses
As a percent of total loans 0.76% 0.76% 1.04%
As a percent of non-margin loans 0.87 0.88 1.24
Total allowance for credit losses
As a percent of total loans 1.11 1.16 1.47
As a percent of non-margin loans 1.28 1.34 1.76
Nonperforming assets
--------------------
Total nonperforming assets $ 29 $ 38 $ 25
Nonperformance assets ratio 0.1% 0.1% 0.1%
2
THE BANK OF NEW YORK COMPANY, INC.
Consolidated Financial Highlights
(Unaudited)
------------------------------------------------------------------------------------
Quarter ended
--------------------------------------
(dollar amounts in millions, except per March 31, Dec. 31, March 31,
share amounts and unless otherwise noted) 2007 2006 2006
------------------------------------------------------------------------------------
Assets under Custody and Administration
---------------------------------------
(in trillions) (1)
--------------------
Assets under Custody and Administration $ 13.8 $ 13.0 $ 11.3
Equity securities 32% 33% 33%
Fixed income securities 68 67 67
Cross-border assets $ 5.0 $ 4.7 $ 3.7
Assets under management (in billions) (2)
-----------------------------------------
Asset and wealth management
Equity securities $ 41 $ 39 $ 37
Fixed income securities 22 21 21
Alternative investments 33 33 26
Liquid assets 34 38 29
-------- -------- --------
Asset and wealth management $ 130 $ 131 $ 113
Foreign exchange overlay 12 11 11
Securities lending short-term
investment funds 54 48 49
-------- -------- --------
Total assets under management $ 196 $ 190 $ 173
======== ======== ========
Capital ratios
--------------
Tier 1 capital ratio 8.43% 8.19% 8.28%
Total capital ratio 12.81 12.49 12.44
Leverage ratio 6.80 6.67 6.51
Adjusted tangible common equity ratio (3) 5.47 5.30 5.54
Average shares outstanding (in thousands)
-----------------------------------------
Basic 750,737 746,688 763,851
Diluted 763,083 757,981 773,630
Other
-----
Book value per common share $ 15.20 $ 15.34 $ 13.09
Tangible book value per common share 6.53 6.57 7.08
Period-end shares outstanding
(in thousands) 758,324 755,861 771,561
Dividends per share $ 0.22 $ 0.22 $ 0.21
Dividend yield 2.17% 2.24% 2.33%
Closing common stock price per share $ 40.55 $ 39.37 $ 36.04
Market capitalization (in billions) 30.8 29.8 27.8
Note:
(1) Estimated Assets under Custody and Administration include assets under
administration and safekeeping.
(2) Estimated
(3) Includes deferred tax liabilities of $154 million for the first quarter of 2007,
$164 million for the fourth quarter of 2006, and $20 million for the first
quarter of 2006 related to non-tax deductible identifiable intangible assets.
3
MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE COMPANY'S FINANCIAL CONDITION
AND RESULTS OF OPERATIONS ("MD&A")
The Bank of New York Company, Inc.'s (the "Company") actual results
of future operations may differ from those estimated or anticipated in
certain forward-looking statements contained herein for reasons which
are discussed below and under the heading "Forward-Looking Statements
and Risk Factors." When used in this report words such as "estimate,"
"forecast," "project," "anticipate," "confident," "target," "expect,"
"intend," "think," "continue," "seek," "believe," "plan," "goal,"
"could," "should," "may," "will," "strategy," "highly attractive,"
"rapidly evolving financial markets," "synergies," "opportunities,"
"superior returns," "well-positioned," "trends," "pro forma" and words
of similar meaning, signify forward-looking statements in addition to
statements specifically identified as forward-looking statements. In
addition, certain business terms used in this document are defined in
the Company's 2006 Annual Report on Form 10-K.
OVERVIEW
The Company's Businesses
The Bank of New York Company, Inc. (NYSE: BK) is a global leader in
providing a comprehensive array of services that enable institutions and
individuals to move and manage their financial assets in more than 100
markets worldwide. The Company has a long tradition of collaborating
with clients to deliver innovative solutions through its core
competencies: securities servicing, treasury management, asset
management, and wealth management. The Company's extensive global
client base includes a broad range of leading financial institutions,
corporations, government entities, endowments and foundations. Its
principal subsidiary, The Bank of New York (the "Bank"), founded in
1784, is the oldest bank in the United States and has consistently
played a prominent role in the evolution of financial markets worldwide.
The Company's strategy over the past decade has been to focus on
highly scalable, fee-based securities servicing and fiduciary
businesses, and it has achieved top three market share in most of its
major product lines. The Company distinguishes itself competitively by
offering one of the industry's broadest array of products and services
around the investment lifecycle. These include:
* advisory and asset management services to support the investment
decision;
* custody, securities lending, accounting, and administrative
services for investment portfolios;
* clearance and settlement capabilities and trade and foreign
exchange execution;
* sophisticated risk and performance measurement tools for analyzing
portfolios; and
* services for issuers of both equity and debt securities.
4
By providing integrated solutions for clients' needs, the Company
strives to be the preferred partner in helping its clients succeed in
the world's rapidly evolving financial markets.
The Company's long-term financial objectives include:
* achieving positive operating leverage over an economic cycle; and
* sustaining top-line growth by expanding client relationships and
winning new ones.
To achieve its long-term objectives, the Company has grown both
through internal reinvestment as well as execution of strategic
acquisitions to expand product offerings and increase market share in
its scale businesses. Internal reinvestment occurs through increased
technology spending, staffing levels, marketing/branding initiatives,
quality programs, and product development. The Company consistently
invests in technology to improve the breadth and quality of its product
offerings, and to increase economies of scale. The Company has acquired
over 90 businesses over the past ten years, almost exclusively in its
securities servicing and asset management areas.
The Company has taken recent actions that have significantly
transformed the Company. During 2006 the Company:
* Agreed to merge with Mellon Financial Corporation ("Mellon"), a
global leader in asset management and securities servicing
* Sold its retail and regional middle market banking businesses
("Retail Business")
* Purchased the corporate trust business (the "Acquired Corporate
Trust Business") of JPMorgan Chase & Co. ("JPMorgan Chase")
* Formed a joint venture known as BNY ConvergEx Group, LLC, a trade
execution and investment technology firm
As part of the transformation to a leading securities servicing
provider, the Company has also de-emphasized or exited several of its
slower growth traditional banking businesses over the past decade. The
Company's more significant actions include selling its credit card
business in 1997 and its factoring business in 1999, significantly
reducing non-financial corporate credit exposures, and most recently, the
sale of the Company's Retail Business. To the extent these actions
generated capital, the capital has been reallocated to the Company's
higher-growth businesses or used to repurchase shares.
5
The Company's business model is well positioned to benefit from a
number of long-term secular trends. These include:
* growth of worldwide financial assets,
* globalization of investment activity,
* structural market changes, and
* increased outsourcing.
These trends benefit the Company by driving higher levels of
financial asset trading volume and other transactional activity, as well
as higher asset price levels and growth in client assets, all factors by
which the Company prices its services. In addition, international
markets offer excellent growth opportunities.
FIRST QUARTER 2007 HIGHLIGHTS
The Company reported first quarter net income of $434 million and
diluted earnings per share of 57 cents. On an adjusted basis, excluding
merger and integration costs, first quarter net income was $449 million
and diluted earnings per share was 59 cents. This compares to net income
of $422 million, or 55 cents of diluted earnings per share, and income
from continuing operations of $360 million, or 47 cents of diluted
earnings per share, in the first quarter of 2006.
Performance highlights for the quarter include:
* Asset servicing revenue grew 17% over the first quarter of 2006,
driven by custody, fund services, and broker-dealer services;
* Asset and wealth management fees were up 20% over the first quarter
of 2006 reflecting organic growth;
* Issuer services results were strong following the seasonally robust
fourth quarter;
* Asset quality remained excellent;
* Good expense discipline drove positive operating leverage.
In the first quarter of 2007, the Company continued its strong
momentum and achieved broad-based growth. The performance reflected the
strength of the Company's business model, which has been built to benefit
from global capital flows and investor activity. The Company benefited
from active capital markets and the increase in net new business remains
favorable.
6
CONSOLIDATED INCOME STATEMENT REVIEW
Noninterest Income
------------------
Continuing Operations
---------------------
Percent Inc/(Dec)
-----------------
1Q07 vs. 1Q07 vs.
(In millions) 1Q07 4Q06 1Q06 4Q06 1Q06
------ ------ ------ -------- -------
Securities servicing fees
Asset servicing $ 393 $ 355 $ 335 11% 17%
Issuer services 319 340 154 (6) 107
Clearing services 278 263 342 6 (19)
------ ------ ------
Securities servicing fees 990 958 831 3 19
Global payment services 50 51 51 (2) (2)
Asset & wealth
management fees 153 154 127 (1) 20
Performance fees 14 18 7 (22) 100
Financing-related fees 52 61 63 (15) (17)
Foreign exchange and
other trading activities 128 98 113 31 13
Securities gains/(losses) 2 2 (4) - 150
Asset/investment income 35 47 34 (26) 3
Other(1) 51 52 43 (2) 19
------ ------ ------
Total noninterest income $1,475 $1,441 $1,265 2 17
====== ====== ======
(1) Includes net economic value payments of $25 million and $23 million for the
first quarter of 2007 and the fourth quarter of 2006.
The results of many of the Company's businesses are influenced by
customer activities that vary by quarter. For instance, consistent with
an overall decline in securities industry activity in the summer, the
Company typically experiences a seasonal decline in the third quarter.
The Company also experiences seasonal increases in securities lending
and depositary receipts reflecting European dividend distribution during
the second quarter of the year, and to a lesser extent, in the fourth
quarter of the year.
The increase in noninterest income versus the year-ago quarter
primarily reflects growth in securities servicing, asset and wealth
management and foreign exchange and other trading activities. The first
quarter of 2007 and the fourth quarter of 2006 reflect the new business
mix including higher revenue from the Acquired Corporate Trust Business
partially offset by the BNY ConvergEx transaction. The sequential-
quarter increase in noninterest income primarily reflects growth in
securities servicing fees and foreign exchange and other trading
revenues.
Securities servicing fees increased over the first quarter period
of 2006 reflects strong growth in asset servicing and issuer services.
Securities servicing fees were up sequentially reflecting growth in
asset servicing and clearing services. See "Institutional Services
Segment" in "Business Segment Review" for additional details.
Global payment services fees were down slightly from the first and
fourth quarters of 2006. Compared with the first quarter of 2006, the
level of fees has been impacted by customers paying with a higher value
of compensatory balances in lieu of fees. Global payment services
includes fees related to funds transfer, cash management, and liquidity
management.
Asset and wealth management fees increased from the first quarter
of 2006 primarily due to growth in assets under management, notably in
alternative investments, as well as the acquisition of Urdang, a real
estate investment management company, in March of last year. Total
assets under management for asset and wealth management were $130
billion at March 31,
7
2007, up from $113 billion at March 31, 2006 and essentially unchanged from
December 31, 2006.
Performance fees were up from a year-ago quarter reflecting strong
results at two of the Company's alternative asset management
subsidiaries, Ivy Asset Management and Alcentra. The sequential-quarter
decline primarily reflects the robust fourth quarter in performance
fees.
Financing-related fees decreased from a year-ago quarter and fourth
quarter of 2006 reflecting a lower level of credit-related activities
consistent with the Company's strategic direction. Finance-related fees
include capital markets and investment banking fees, loan commitment
fees and credit-related trade fees.
Foreign exchange and other trading revenues were up sequentially
and from the first quarter of 2006 reflecting an increase in other
trading activities driven by interest rate derivatives and hedging
transactions. Foreign exchange revenue increased on a sequential quarter
basis consistent with higher market volatility and volumes in late
February and early March. Foreign exchange results were down from the
first quarter of 2006 reflecting lower market volatility.
Asset/investment income in the quarter reflected continued strong
returns on investments in the sponsor fund portfolio. Venture capital
income was $17 million in the first quarter of 2007, down from $29
million in the fourth quarter of 2006 and $23 million in the first
quarter of 2006. In the fourth quarter of 2006, the Company sold one of
its sponsor fund investments to a third party for a realized gain of $11
million. Asset/investment income includes the gains and losses on
private equity investments, income from insurance contracts, and lease
residual gains and losses.
Other noninterest income is comprised of asset-related gains,
equity investment income, net economic value payments, and other
transactions. Asset-related gains include loan and real estate
dispositions. Equity investment income primarily reflects the
Company's proportionate share of the income from its investment in Wing
Hang Bank Limited. Other income primarily includes low income housing,
other investments and various miscellaneous revenues.
The breakdown among these four categories is shown below:
Other Noninterest Income
(In millions) 1Q07 4Q06 1Q06
------------------------------- ------- ------- -------
Asset-related gains $ 12 $ 19 $ 34
Equity investment income 13 11 11
Net economic value payments 25 23 -
Other 1 (1) (2)
------- ------- -------
Other noninterest income $ 51 $ 52 $ 43
======= ======= =======
Other noninterest income decreased versus fourth quarter of 2006
reflecting lower asset-related gains. The first quarter 2007 results
include net economic value payments of $25 million compared with $23
million in the fourth quarter of 2006 on corporate trust deposits that
have not yet transitioned to the Company's balance sheet. The first
quarter of 2006 included pre-tax gain of $31 million related to the
conversion of the Company's New York Stock Exchange seats into cash and
shares of NYSE Group, Inc. common stock. The fourth quarter 2006 results
include a $6 million loss related to low-income housing investments.
8
Net Interest Income
-------------------
Continuing Operations
---------------------
Percent Inc/(Dec)
-----------------
(Dollars in millions) 1Q07 vs. 1Q07 vs.
1Q07 4Q06 1Q06 4Q06 1Q06
---- ---- ---- -------- --------
Net interest income $427 $451 $339 (5)% 26%
Tax equivalent
adjustment(1) 2 1 7
---- ---- ----
Net interest income
on a tax equivalent basis $429 $452 $346 (5) 24
==== ==== ====
Net interest margin 2.18% 2.27% 1.95%
(1) Selected items included in net interest income have been adjusted to a tax equivalent
basis as shown above. To calculate the tax equivalent revenues and profit or loss, the Company
adjusts tax-exempt revenues and the income or loss from such tax-exempt revenues to show these
items as if they were taxable, applying an assumed tax rate of 35 percent. The Company
believes that this presentation provides comparability of net interest income arising from
both taxable and tax-exempt sources and is consistent with industry standards.
Net interest income and net interest margin increased from the
first quarter of 2006 reflecting higher deposit balances associated
with the Acquired Corporate Trust Business, as well as higher amounts
of interest-earning assets and interest-free balances and the greater
value of interest-free balances in a higher rate environment.
The sequential-quarter decrease in net interest income and net
interest margin was driven by a lower volume of low cost deposits
associated with the securities servicing business and fewer days in
the quarter. Net interest margin was 2.18% in the first quarter of
2007, compared with 1.95% in the first quarter of 2006 and 2.27% in
the fourth quarter of 2006.
Net interest income does not reflect the impact of certain
deposits of the Acquired Corporate Trust Business which are expected
to transition to the Company's balance sheet in the second quarter of
2007. Pro forma for the inclusion of these deposits and the
associated economic value on these deposits, the net interest margin
would have been approximately 2%.
9
Noninterest Expense and Income Taxes
------------------------------------
Continuing Operations
---------------------
Percent Inc/(Dec)
-----------------
1Q07 vs. 1Q07 vs.
(In millions) 1Q07 4Q06 1Q06 4Q06 1Q06
------ ------ ------ -------- --------
Staff $ 720 $ 736 $ 604 (2)% 19%
Net occupancy 79 73 68 8 16
Furniture and equipment 50 45 51 11 (2)
Clearing 37 38 50 (3) (26)
Sub-custodian expenses 34 33 34 3 -
Software 54 59 55 (8) (2)
Business development 30 30 23 - 30
Communications 19 23 26 (17) (27)
Professional, legal and
other purchased services 130 125 82 4 59
Distribution and servicing 4 5 4 (20) -
Amortization of intangibles 28 34 13 (18) 115
Merger and integration costs 15 17 - (12) NM
Other 72 67 59 7 22
------ ------ ------
Total noninterest expense 1,272 1,285 1,069 (1) 19
Merger and integration costs (15) (17) - (12) NM
------ ------ ------
Total noninterest expense excluding
merger and integration costs $1,257 $1,268 $1,069 (1) 18
====== ====== ======
NM - Not meaningful
Noninterest expense was up compared with the first quarter of 2006 and
down on a sequential-quarter basis.
The decline in sequential quarter expenses reflects strong expense
discipline across many of the Company's businesses.
* The decrease in staff expense reflects lower incentive compensation
and pension expenses.
Staff expense is comprised of:
- compensation expense, which includes
* base salary expense, primarily driven by headcount,
* the cost of temporary help and overtime, and
* severance expense;
- incentive expense, which includes
* additional compensation earned under a wide range of
sales commission plans and incentive plans designed to
reward a combination of individual, business unit and
corporate performance versus goals, and
* stock option expense; and
- employee benefit expense, primarily medical benefits, payroll
taxes, pension and other retirement benefits.
* The increase in net occupancy primarily reflects the conversion of
AIB/BNY Securities Servicing (Ireland) Ltd. ("AIB/BNY") to a
wholly-owned subsidiary.
10
* The fourth quarter of 2006's amortization of intangibles included a
$6 million impairment charge related to the write-off of customer
intangibles.
* Other expense included transition services expense and other costs
related to the Acquired Corporate Trust Business of $21 million in
the current quarter and $22 million in the fourth quarter of 2006.
* Merger and integration expense in the first quarter of 2007
included $11 million related to the Acquired Corporate Trust
Business and $4 million related to the anticipated merger with
Mellon.
The purchase of the Acquired Corporate Trust Business and the
remaining 50% of AIB/BNY joint venture, along with the disposition of
certain execution businesses in the BNY ConvergEx transaction,
significantly impacts comparisons of the first quarter of 2007 to the
first quarter of 2006. The net impact of these transactions was to
increase staff expense, net occupancy, business development,
professional, legal, and other purchased services, amortization of
intangibles, and other expense. The BNY ConvergEx transaction also
resulted in lower clearing expenses.
The effective tax rate for the first quarter of 2007 was 32.2%,
compared to 32.7% in the first quarter of 2006 and 31.4% in the fourth
quarter of 2006. The decrease from the first quarter of 2006 primarily
reflects foreign sales corporation benefits for certain leverage leases.
The sequential quarter increase reflects lower Section 29 tax credits
related to synthetic fuel.
The Company's effective tax rate in the future is expected to be
impacted by the price of oil, which determines the amount of synthetic
fuel tax credits (Section 29 of the Internal Revenue Code) it will
receive. These credits relate to investments that produce alternative
fuel from coal byproducts.
To manage its exposure in 2007 to the risk of an increase in oil
prices that could reduce synthetic fuel tax credits, the Company entered
into an option contract covering a specified number of barrels of oil
that settles at the end of 2007. The option contract economically hedges
a portion of the Company's projected 2007 synthetic fuel tax credit
benefit. The contract does not qualify for hedge accounting and, as a
result, changes in the fair value of the option will be recorded
currently in trading income. The Company may enter into further option
contracts to protect against fluctuations in oil prices.
At March 31, 2007, the Company assumed a $73 average price per
barrel after March 31, 2007 to estimate the 2007 benefit from synthetic
fuel credits. To the extent the average oil price differs from this
assumption, the table below shows the estimated effect on earnings per
share ("EPS") for 2007.
Avg. Price
Per Barrel Option Contract
March 31, 2007 - Phase- Net Benefit Benefit/ (Cost) EPS
December 31, 2007 out % (In millions) (In millions) Effect
-------------------- -------- ----------- --------------- --------
$ 67 8.4% $ 52.1 $(1.5) $ 0.02
69 18.8 46.2 1.5 0.02
---------------------------------------------------------------------
| 73 40.0 34.1 7.7 0.01|(1)
---------------------------------------------------------------------
75 50.2 28.3 10.6 0.01
77 60.7 22.4 12.1 0.00
(1) March 31, 2007 assumption used to compute effective tax rate.
If the 2007 annual average price per barrel of oil were to go below
$64 or above $78, there would be no additional EPS effect.
11
Credit Loss Provision and Net Charge-Offs
-----------------------------------------
(In millions)
1Q07 4Q06 1Q06
------- ------- -------
Provision $ (15) $ (15) $ -
======= ======= =======
Net (charge-offs)/recoveries:
Commercial $ 3 $ (23) $ 2
Foreign - (1) 2
------- ------- -------
Total net
(charge-offs)/recoveries $ 3 $ (24) $ 4
======= ======= =======
The provision for credit losses for the first quarter of 2007 was a
credit of $15 million, compared with zero in the first quarter of 2006
and a credit of $15 million in the fourth quarter of 2006 reflecting
continuing high credit quality. The Company recorded a net recovery of $3
million in the first quarter of 2007, compared with a net recovery of $4
million in the first quarter of 2006 and a net charge-off of $24 million
in the fourth quarter of 2006. The first quarter of 2007 reflects a $7
million recovery related to leased aircraft that were sold. During the
fourth quarter of 2006, the Company sold $38 million of domestic airline
leasing exposure resulting in a charge-off of $23 million.
12
BUSINESS SEGMENT REVIEW
Segment Data
The Company has an internal information system that produces
performance data for its three business segments along product and
service lines.
Business Segments Accounting Principles
The Company's segment data has been determined on an internal
management basis of accounting, rather than the generally accepted
accounting principles used for consolidated financial reporting. These
measurement principles are designed so that reported results of the
segments will track their economic performance. Segment results are
subject to restatement whenever improvements are made in the
measurement principles or when organizational changes are made.
The Company continuously updates segment information for changes
that occur in the management of its businesses. In the first quarter of
2007, in connection with the anticipated merger with Mellon, business
segment reporting was realigned to reflect the planned new business
structure of the combined company. In addition, several allocation
methodologies were also revised to achieve greater harmonization with
Mellon's methodologies. All prior periods have been restated to reflect
these revisions. It is anticipated that most remaining allocation
methodologies will be harmonized during the second quarter of 2007.
The Company now provides segment data for three segments with the
Asset and Wealth Management Segment and Institutional Services Segment
being further divided into business groupings. These segments are shown
below:
* Asset and Wealth Management Segment
- Asset Management Business
- Wealth Management Business
* Institutional Services Segment
- Asset Servicing Business
- Clearing & Execution Services Business
- Issuer Services Business
- Treasury Services Business
* Other Segment
On October 1, 2006, the Company sold substantially all of the
assets of its Retail Business.
Specific segment accounting principles employed include:
* Revenue amounts reflect fee revenues generated by each segment.
* Revenues and expenses associated with specific client bases are
included in those segments. For example, foreign exchange
activity associated with clients using custody products is
allocated to Asset Servicing Business within the Institutional
Services Segment (which includes the Company's custody
operations.)
* Balance sheet assets and liabilities and their related income or
expense are specifically assigned to each segment. Previously
segments with a net liability position would have also been
allocated assets from the securities portfolio.
* Net interest income is allocated to segments based on the yields
on the assets and liabilities generated by each segment. The
Company employs a funds transfer pricing system that match funds
the specific assets and liabilities of each segment based on
their interest sensitivity and maturity characteristics.
* The measure of revenues and profit or loss by a segment has been
adjusted to present segment data on a tax equivalent basis.
13
* The provision for credit losses is allocated to segments based on
changes in each segment's credit risk during the period. Previously
the provision for credit losses was based on management's judgment
as to average credit losses that would have been incurred in the
operations of the segment over a credit cycle of a period of years.
* Support and other indirect expenses are allocated to segments
based on internally-developed methodologies.
* Goodwill and intangibles are reflected within individual business
segments.
* The business segment information is reported on a continuing
operations basis for all periods presented.
* The operations of the Acquired Corporate Trust Business are
included only from October 1, 2006, the date on which it was
acquired.
DESCRIPTION OF BUSINESS SEGMENTS
The activities within each business segment are described below.
Asset and Wealth Management Segment
-----------------------------------
Asset Management Business
-------------------------
Asset Management provides investment solutions predominately to
institutional investors around the world applying a broad spectrum of
investment strategies. Asset Management's alternative strategies have
expanded to include funds of hedge funds, private equity, alternative
fixed income, and real estate.
The Company's asset management subsidiaries include:
* Ivy Asset Management Corporation, one of the country's leading
fund of hedge funds firms, offers a comprehensive range of multi-
manager hedge fund products and customized portfolio solutions.
* Alcentra offers sophisticated alternative credit investments,
including leveraged loans and subordinated and distressed debt.
* Urdang, a real estate investment firm, offers the opportunity to
invest in real estate through separate accounts, a closed-end
commingled fund that invests directly in properties, and a
separate account that invests in publicly-traded real estate
investment trusts.
* Estabrook Capital Management LLC offers value-oriented investment
management strategies, including socially responsible investing.
* Gannett, Welsh & Kotler specializes in tax-exempt securities
management and equity portfolio strategies.
The Company also provides investment management services directly
to institutions and manages the "Hamilton" family of mutual funds.
Wealth Management Business
--------------------------
In this business, the Company offers a full array of investment
management, wealth management, and comprehensive financial management
services to help individuals plan, invest, and arrange
intergenerational wealth transition, which includes financial and
estate planning, trust and fiduciary services, customized banking
services, and brokerage and investment solutions. Clients include
predominately high-net-worth individuals, families, family offices,
charitable gift programs, endowments, foundations, professionals, and
entrepreneurs.
14
Institutional Services Segment
------------------------------
Asset Servicing Business
------------------------
Asset Servicing includes global custody, global fund services,
securities lending, global liquidity services, outsourcing, government
securities clearance, collateral management, credit-related services,
and other linked revenues, principally foreign exchange. Clients include
corporate and public retirement funds, foundations and global financial
institution including banks, broker-dealers, investment managers,
insurance companies, and mutual funds.
The Company is one of the leading asset service companies with
$13.8 trillion of Assets under Custody and Administration at March 31,
2007. The Company is one of the largest mutual fund custodians for
U.S. funds and one of the largest providers of fund services in the
world with over $2.0 trillion in total assets. The Company also
services more than 45% of the exchange-traded funds in the United
States, and is a leading U.K. custodian. In securities lending, the
Company is one of the largest lenders of U.S. Treasury securities and
depositary receipts with a lending pool of approximately $1.8 trillion
in 27 markets around the world.
The Company clears approximately 50% of transactions in U.S.
Government securities. The Company is a leader in global clearance,
clearing equity and fixed income transactions in 101 markets. With $1.5
trillion in tri-party balances worldwide, the Company is a leading
collateral management agent.
Clearing & Execution Services Business
--------------------------------------
The Company's Clearing & Execution Services Business consists of
its Pershing clearing business, its 35% equity interest in BNY
ConvergEx Group and the Company's B-Trade and G-Trade businesses, which
are expected to become part of the BNY ConvergEx Group in 2008. The BNY
ConvergEx transaction changed the accounting from a fully consolidated
subsidiary to a 35% equity interest recorded in other income.
The Company's Pershing subsidiary provides clearing, execution,
financing, and custody for introducing broker-dealers and registered
investment advisors. Pershing services more than 1,150 retail and
institutional financial organizations and independent investment
advisors with more than five million active accounts.
Through its affiliate, BNY ConvergEx Group, the Company provides
execution solutions, investment technologies, commission management,
research, transition management and wholesale and outsourcing solutions
in over 90 global markets, executing 553 million shares each day and
clearing more than 1.3 million trades daily.
In execution services, the Company provides broker-assisted and
electronic trading services. The Company's execution services business
is one of the largest global institutional agency brokerage
organizations. In addition, it is one of the leading institutional
electronic brokers for non-U.S. dollar equity execution.
Issuer Services Business
------------------------
Issuer Services includes corporate trust, depositary receipts,
employee investment plan services, and stock transfer.
In Issuer Services, the Company is depositary for more than 1,270
American and global depositary receipt programs, with a 64% market
share, servicing leading companies from 62 countries. As the world's
largest trustee, the Company provides diverse services for corporate,
municipal, structured, and international debt securities. The Company
serves as trustee for some 90,000 clients with more than $8 trillion in
outstanding
15
debt securities. The Company is the third largest stock
transfer agent in the United States, servicing more than 17 million
shareowners. Employee Investment Plan Services has more than 120
clients with 650,000 employees in over 54 countries.
Treasury Services Business
--------------------------
Treasury Services includes global payment services for corporate
customers as well as lending and credit-related services.
Corporate Global Payment Services offers leading-edge technology,
innovative products, and industry expertise to help its clients
optimize cash flow, manage liquidity, and make payments around the
world in more than 90 different countries. The Company maintains a
global network of branches, representative offices and correspondent
banks to provide comprehensive payment services including funds
transfer, cash management, trade services and liquidity management.
The Company is one of the largest funds transfer banks in the U.S.
transferring over $1.4 trillion daily via more than 150,000 wire
transfers.
The Company provides lending and credit-related services to large
public and private corporations and financial institutions nationwide.
Through BNY Capital Markets, Inc., the Company provides a broad range
of capital markets services including syndicated loans, bond
underwriting, and private placements of corporate debt and equity
securities.
For its credit services business overall, the Company's corporate
lending strategy is to focus on those clients and industries that are
major users of securities servicing and global payment services.
Other Segment
-------------
The Other Segment primarily includes the Company's leasing
operations, investing and funding operations, and corporate overhead.
The tax equivalent adjustment on net interest income is eliminated in
this segment. Noninterest income primarily reflects leasing,
securities gains, and income from the sale of other corporate assets.
Noninterest expenses include direct expenses supporting the leasing,
investing, and funding activities as well as certain corporate overhead
not directly attributable to the operations of the other segments.
In addition, this segment includes expenses previously allocated to
the Company's Retail and Middle Market Banking Segment that did not
qualify for treatment as discontinued operations expense.
16
Market Data
-----------
Percent Inc/(Dec)
------------------
1Q07 vs. 1Q07 vs.
1Q07 4Q06 3Q06 2Q06 1Q06 4Q06 1Q06
------- -------- -------- -------- -------- -------- --------
S&P 500 Index(1) 1,421 1,418 1,336 1,270 1,295 -% 10%
NASDAQ Composite
Index(1) 2,422 2,415 2,258 2,172 2,340 - 4
Lehman Brothers
Aggregate Bond
(service mark)
Index(1) 230.8 226.6 220.0 213.2 205.9 2 12
MSCI EAFE (registered
trademark)
Index(1) 2,147.5 2,074.5 1,885.3 1,822.9 1,827.7 4 17
NYSE Volume
(In billions) 123.8 114.4 108.8 121.6 113.7 8 9
NASDAQ Volume
(In billions) 123.5 121.5 114.6 134.2 130.8 2 (6)
(1) Period End
The results of many of the Company's businesses are influenced by
customer activities that vary by quarter. For instance, consistent with
an overall decline in securities industry activity in the summer, the
Company typically experiences a seasonal decline in the third quarter.
The Company also experiences seasonal increases in securities lending
and depositary receipts reflecting the European dividend distribution
season during the second quarter of the year, and to a lesser extent,
in the fourth quarter of the year.
The first quarter of 2007 was impacted by a seasonal decline in
corporate actions that reduced revenue related to depositary receipts
and securities lending. Non-program equity trading volumes were up 10%
sequentially and year-over-year. In addition, average daily U.S.
fixed-income trading volume was up 8% sequentially and 4% year-over-
year. Total debt issuance increased 4% sequentially and 12% year-over-
year. The issuance of global collateralized debt obligations is up 47%
versus the first quarter of 2006.
As of March 31, 2007, Assets under Custody and Administration rose
to $13.8 trillion, from $11.3 trillion at March 31, 2006 and $13.0
trillion at December 31, 2006. The increase in Assets under Custody
and Administration relative to March 31, 2006 primarily reflects rising
asset prices, growth in the custody business, and the impact of the
Acquired Corporate Trust Business. Equity securities comprised 32% of
the Assets under Custody and Administration at March 31, 2007, compared
with 33% at March 31, 2006, while fixed-income securities were 68%
compared with 67% at March 31, 2006. Assets under Custody and
Administration at March 31, 2007 consisted of assets related to the
custody, mutual funds, and corporate trust businesses of $9.6 trillion,
broker-dealer services assets of $2.4 trillion, and all other assets of
$1.8 trillion.
17
Segment Analysis
Asset and Wealth Management Segment
-----------------------------------
Assets Under Management - Asset and Wealth Management
-----------------------------------------------------
(In billions)- Estimated 1Q07 4Q06 3Q06 2Q06 1Q06
------ ------ ------ ------ ------
Equity securities $ 41 $ 39 $ 36 $ 36 $ 37
Fixed-income securities 22 21 20 21 21
Alternative investments 33 33 30 28 26
Liquid assets 34 38 34 31 29
---- ---- ---- ---- ----
Total assets under management $130 $131 $120 $116 $113
==== ==== ==== ==== ====
Assets under management ("AUM") were $130 billion at March 31,
2007, compared with $113 billion at March 31, 2006, and $131 billion at
December 31, 2006. The year-over-year increase in AUM primarily
reflects the continued good growth across asset classes and strategies.
Institutional clients represent 76% of AUM while individual clients
equal 24%. At March 31, 2007, such assets were invested 32% in
equities, 17% in fixed income, and 26% in alternative investments, with
the remaining amount invested in liquid assets.
Asset Management Business
-------------------------
Inc/(Dec)
------------------
1Q07 vs. 1Q07 vs.
(In millions) 1Q07 4Q06 3Q06 2Q06 1Q06 4Q06 1Q06
------------------- ------- ------- ------- ------- ------- -------- --------
Mutual funds $ 3 $ 3 $ 2 $ 3 $ 2 $ - $ 1
Institutional clients 68 72 64 61 55 (4) 13
Private clients 13 13 12 12 11 - 2
------- ------- ------- ------- -------
Total asset
management fees 84 88 78 76 68 (4) 16
Performance fees 14 18 3 7 7 (4) 7
Securities servicing fees - 1 1 1 1 (1) (1)
Other 3 2 2 1 3 1 -
------- ------- ------- ------- -------
Total noninterest income 101 109 84 85 79 (8) 22
Net interest income 5 6 3 3 2 (1) 3
------- ------- ------- ------- -------
Total revenue 106 115 87 88 81 (9) 25
Noninterest expense 65 72 57 54 49 (7) 16
------- ------- ------- ------- -------
Income before taxes $ 41 $ 43 $ 30 $ 34 $ 32 (2) 9
======= ======= ======= ======= =======
Average assets $ 1,387 $ 1,226 $ 1,082 $ 1,055 $ 925 161 462
Average deposits 61 98 86 92 105 (37) (44)
Income before taxes was up 28% to $41 million for the first
quarter of 2007 from $32 million in the first quarter of 2006, and down
5% from $43 million in the fourth quarter of 2006.
Noninterest income increased $22 million, or 28%, in the first
quarter of 2007 compared with the first quarter of 2006 reflecting
higher asset management fees from institutional clients. Performance
fees were up reflecting strong results at two of the Company's
alternative asset management subsidiaries, Ivy Asset Management and
Alcentra.
Noninterest income declined on a sequential-quarter basis
reflecting lower performance fees.
Net interest income increased $3 million compared with the first
quarter of 2006, driven by higher interest-earning assets. On a
sequential-quarter basis, the decline in net interest income reflects a
lower spread on interest-earning assets. Average deposits were $0.1
billion in the first
18
quarter of 2007, first quarter of 2006 and fourth quarter of 2006. Average
assets were $1.4 billion in the first quarter of 2007, compared with $0.9
billion in the first quarter of 2006 and $1.2 billion in the fourth quarter
of 2006.
Noninterest expense increased $16 million, or 33%, in the first
quarter of 2007 compared with the first quarter of 2006 reflecting
higher incentive compensation and outside help. The sequential-quarter
decline in noninterest expense primarily reflects lower incentive
compensation.
Wealth Management Business
--------------------------
Inc/(Dec)
------------------
1Q07 vs. 1Q07 vs.
(In millions) 1Q07 4Q06 3Q06 2Q06 1Q06 4Q06 1Q06
------------------- ------- ------- ------- ------- ------- -------- --------
Securities servicing fees $ - $ - $ - $ - $ 1 $ - $ (1)
Wealth management fees 50 48 46 50 49 2 1
Other 1 1 1 1 1 - -
------- ------- ------- ------- -------
Total noninterest income 51 49 47 51 51 2 -
Net interest income 15 14 16 13 16 1 (1)
------- ------- ------- ------- -------
Total revenue 66 63 63 64 67 3 (1)
Provision for credit losses - - - (2) - - -
Noninterest expense 53 51 51 51 52 2 1
------- ------- ------- ------- -------
Income before taxes $ 13 $ 12 $ 12 $ 15 $ 15 1 (2)
======= ======= ======= ======= =======
Average assets $ 1,448 $ 1,481 $ 1,503 $ 1,446 $ 1,525 (33) (77)
Average deposits 1,052 1,003 1,039 1,021 1,042 49 10
Income before taxes was down 13% to $13 million for the first
quarter of 2007 from $15 million in the first quarter of 2006, and was
up 8% from $12 million in the fourth quarter of 2006.
Total noninterest income was flat on a year-over-year basis. The
sequential-quarter increase reflects growth in wealth management fees.
Net interest income decreased $1 million, or 6%, compared with the
first quarter of 2006, reflecting the decline in the spread on earning
assets. Average deposits were $1.1 billion in the first quarter of
2007, compared with $1.0 billion in the first quarter of 2006 and $1.0
billion in the fourth quarter of 2006. Average assets were $1.4 billion
in the first quarter of 2007, compared with $1.5 billion in the first
quarter of 2006 and $1.5 billion in the fourth quarter of 2006.
Noninterest expense increased $1 million, or 2%, in the first
quarter of 2007 compared with the first quarter of 2006 primarily
reflecting higher salaries, outside help and occupancy expense. The
sequential-quarter increase reflects higher outsourcing partially
offset by lower technology expense.
19
Institutional Services Segment
------------------------------
Asset Servicing Business
------------------------
Inc/(Dec)
------------------
1Q07 vs. 1Q07 vs.
(In millions) 1Q07 4Q06 3Q06 2Q06 1Q06 4Q06 1Q06
------------------- ------- ------- ------- ------- ------- -------- --------
Securities servicing fees $ 388 $ 350 $ 351 $ 371 $ 341 $ 38 $ 47
Foreign exchange 68 54 50 79 66 14 2
Other 15 17 23 21 17 (2) (2)
------- ------- ------- ------- -------
Total noninterest income 471 421 424 471 424 50 47
Net interest income 127 132 117 113 103 (5) 24
------- ------- ------- ------- -------
Total revenue 598 553 541 584 527 45 71
Noninterest expense 424 410 400 399 383 14 41
------- ------- ------- ------- -------
Income before taxes $ 174 $ 143 $ 141 $ 185 $ 144 31 30
======= ======= ======= ======= =======
Average assets $10,610 $ 9,453 $ 8,641 $ 8,873 $ 7,418 1,157 3,192
Average deposits 24,648 24,335 24,115 23,937 21,748 313 2,900
Securities lending revenue 36 35 40 50 45 1 (9)
Income before taxes was up 21% to $174 million for the first
quarter of 2007 from $144 million in the first quarter of 2006, and up
22% from $143 million in the fourth quarter of 2006.
Total noninterest income increased $47 million, or 11%, in the
first quarter of 2007 compared with the first quarter of 2006 driven by
increased transaction volumes and organic growth across all business
products, especially global custody, domestic and international mutual
funds, exchange-traded funds, hedge fund servicing and collateral
management. European asset servicing continues to gain momentum with
strong first quarter revenue growth across all products, again
reflective of the significant cross-border investment interest and
capital flow. In addition, the Company benefited from the conversion of
AIB/BNY to a wholly-owned subsidiary in the fourth quarter of 2006.
Securities lending revenue was flat on a sequential-quarter basis and
down from the first quarter of 2006 as increased volumes were more than
offset by the exceptionally tight spread between the Treasury repo rate
and Fed funds rate. In hedge fund services during the quarter, the
Company surpassed the $100 billion mark in assets under administration.
In broker-dealer services, the continued adoption of tri-party
repo arrangements remains a key driver. The growth in global clearance
was due to new business wins and increased volume from existing
clients. The Company now handles approximately $1.5 trillion of
financing for the Company's broker-dealer clients daily through
collateralized financing agreements, up approximately 18% from a year
ago.
Foreign exchange revenue increased on a sequential-quarter basis
consistent with higher market volatility and volumes in late February
and early March. Foreign exchange results were up from the first
quarter of 2006 reflecting greater cross-border flows.
Net interest income increased $24 million compared with the first
quarter of 2006, primarily driven by deposit growth coupled with the
higher value of deposits in a rising rate environment. The sequential-
quarter decline is due to a lower spread on interest-earning foreign
deposits. Average deposits were $24.6 billion in the first quarter of
2007, compared with $21.7 billion in the first quarter of 2006 and
$24.3 billion in the fourth quarter of 2006. The growth in deposits
reflects greater customer activity in the Company's asset servicing
businesses. Average assets were $10.6 billion in the first quarter of
2007, compared with $7.4 billion in the first quarter of 2006 and $9.5
billion in the fourth quarter of 2006.
20
Noninterest expense increased $41 million, or 11%, in the first
quarter of 2007 compared with the first quarter of 2006 reflecting
increased incentive compensation, salaries, outside help, sub-custodian
fees, net occupancy expense, claims by customers and technology. The
sequential-quarter increase is primarily due to increased claims by
customers, salaries, outside help, net occupancy expense, and sub-
custodian fees.
Clearing & Execution Services Business
--------------------------------------
Inc/(Dec)
------------------
1Q07 vs. 1Q07 vs.
(In millions) 1Q07 4Q06 3Q06 2Q06 1Q06 4Q06 1Q06
------------------- ------- ------- ------- ------- ------- -------- --------
Securities servicing fees $ 286 $ 271 $ 293 $ 328 $ 332 $ 15 $ (46)
Asset & wealth management 11 10 9 9 9 1 2
Foreign exchange and other
trading activities 10 10 10 11 11 - (1)
Other 6 10 19 7 34 (4) (28)
------- ------- ------- ------- -------
Total noninterest income 313 301 331 355 386 12 (73)
Net interest income 59 62 58 54 53 (3) 6
------- ------- ------- ------- -------
Total revenue 372 363 389 409 439 9 (67)
Provision for credit losses - 2 - (4) (2) (2) 2
Noninterest expense 272 257 306 307 303 15 (31)
------- ------- ------- ------- -------
Income before taxes $ 100 $ 104 $ 83 $ 106 $ 138 (4) (38)
======= ======= ======= ======= =======
Average assets $16,363 $14,825 $16,363 $17,175 $17,381 1,538 (1,018)
Average interest-bearing
payables to customers and
broker-dealers 4,747 4,683 4,657 5,034 5,231 64 (484)
Income before taxes was down 28% to $100 million for the first
quarter of 2007 from $138 million in the first quarter of 2006, and
down 4% from $104 million in the fourth quarter of 2006. The decline
in results from the first quarter of 2006 reflects the $31 million gain
related to the first quarter of 2006 conversion of the Company's New
York Stock Exchange seats into cash and shares of the NYSE Group, Inc.
common stock.
Total noninterest income decreased $73 million, or 19%, in the
first quarter of 2007 compared with the first quarter of 2006.
Securities servicing fees declined reflecting the disposition of
certain execution businesses in the BNY ConvergEx transaction. These
businesses had revenues of $90 million in the first quarter of 2006.
On a sequential-quarter basis, securities servicing fees were up $15
million, or 6%, reflecting solid performance at Pershing as well as the
benefits of new business acquired. The decline in other from the first
quarter of 2006 reflects the aforementioned NYSE Group, Inc.
transaction.
Net interest income increased $6 million, or 11%, compared with
the first quarter of 2006, resulting from a higher spread on interest-
earning assets in a rising rate environment. The sequential-quarter
decline in net interest income reflects a lower spread on interest-
earning assets. Average assets were $16.4 billion in the first quarter
of 2007, compared with $17.4 billion in the first quarter of 2006 and
$14.8 billion in the fourth quarter of 2006. Average interest-bearing
payables to customers and broker-dealers were $4.7 billion in the first
quarter of 2007, compared with $5.2 billion in the first quarter of
2006 and $4.7 billion in the fourth quarter of 2006. The decline from a
year-ago quarter reflects loss of a significant customer at Pershing.
Noninterest expense decreased $31 million, or 10%, in the first
quarter of 2007 compared with the first quarter of 2006 reflecting
lower
21
clearing expense, commissions, incentive compensation, and the
disposition of certain execution businesses in the BNY ConvergEx
transaction. The sequential-quarter increase in noninterest expense
reflects higher incentive compensation, salaries, outside help and
clearing expense.
Issuer Services Business
------------------------
Inc/(Dec)
------------------
1Q07 vs. 1Q07 vs.
(In millions) 1Q07 4Q06 3Q06 2Q06 1Q06 4Q06 1Q06
------------------- ------- ------- ------- ------- ------- -------- --------
Securities servicing fees $ 319 $ 340 $ 197 $ 209 $ 156 $ (21) $ 163
Other 37 31 8 11 9 6 28
------- ------- ------- ------- -------
Total noninterest income 356 371 205 220 165 (15) 191
Net interest income 105 101 47 52 45 4 60
------- ------- ------- ------- -------
Total revenue 461 472 252 272 210 (11) 251
Provision for credit losses - (1) 1 - - 1 -
Noninterest expense 237 236 122 122 110 1 127
------- ------- ------- ------- -------
Income before taxes $ 224 $ 237 $ 129 $ 150 $ 100 (13) 124
======= ======= ======= ======= =======
Average assets $ 4,235 $ 3,988 $ 1,359 $ 1,316 $ 1,351 247 2,884
Average deposits 11,718 10,942 5,844 6,361 5,843 776 5,875
Income before taxes was up 124% to $224 million for the first
quarter of 2007 from $100 million in the first quarter of 2006, and
down 5% from $237 million in the fourth quarter of 2006.
Total noninterest income increased $191 million, or 116%, in the
first quarter of 2007 compared with the first quarter of 2006. Issuer
services fees continued to exhibit strong growth in the first quarter
compared with last year's first quarter. The Acquired Corporate Trust
Business significantly impacts comparisons of the first quarter of 2007
to the first quarter of 2006. Corporate trust fees increased
sequentially over the strong fourth quarter reflecting continued strong
performance in global products and structured finance, notably asset-
backed and mortgage-backed securities and CDOs. Depositary receipts had
another quarter of double-digit growth and the Company continues to see
strong underlying activity, particularly from emerging markets. On a
sequential-quarter basis, depositary receipt fees declined consistent
with normal seasonal patterns for corporate actions.
Net interest income increased $60 million, or 133%, in the first
quarter of 2007 compared with the first quarter of 2006, primarily
resulting from the Acquired Corporate Trust Business. The sequential-
quarter increase in net interest income was driven by higher value on
both interest-bearing and noninterest-bearing deposits. Average
deposits were $11.7 billion in the first quarter of 2007, compared with
$5.8 billion in the first quarter of 2006 and $10.9 billion in the
fourth quarter of 2006. The higher levels of deposits reflects the
Acquired Corporate Trust Business as well as increased liquidity from
the Company's other issuer services customers compared with 2006.
Average assets were $4.2 billion in the first quarter of 2007, compared
with $1.4 billion in the first quarter of 2006 and $4.0 billion in the
fourth quarter of 2006.
Noninterest expense increased $127 million, or 115%, in the first
quarter of 2007 compared with the first quarter of 2006 reflecting the
impact of the Acquired Corporate Trust Business and expenses associated
with revenue growth in depositary receipts and corporate trust. The
sequential-quarter increase reflects higher salaries, outside help and
commissions offset by lower incentive compensation, outsourcing and
sub-custodian fees.
22
Treasury Services Business
--------------------------
Inc/(Dec)
------------------
1Q07 vs. 1Q07 vs.
(In millions) 1Q07 4Q06 3Q06 2Q06 1Q06 4Q06 1Q06
------------------- ------- ------- ------- ------- ------- -------- --------
Global payment services $ 48 $ 50 $ 53 $ 50 $ 49 $ (2) $ (1)
Financing-related fees 38 42 46 47 45 (4) (7)
Other 46 40 42 59 41 6 5
------- ------- ------- ------- -------
Total noninterest income 132 132 141 156 135 - (3)
Net interest income 94 99 96 97 95 (5) (1)
------- ------- ------- ------- -------
Total revenue 226 231 237 253 230 (5) (4)
Provision for credit losses (3) (7) (3) 7 8 4 (11)
Noninterest expense 117 117 115 120 111 - 6
------- ------- ------- ------- -------
Income before taxes $ 112 $ 121 $ 125 $ 126 $ 111 (9) 1
======= ======= ======= ======= =======
Average assets $17,003 $16,615 $16,680 $16,279 $15,521 388 1,482
Average deposits 13,576 14,529 12,707 12,261 11,873 (953) 1,703
Income before taxes was up 1% to $112 million for the first
quarter of 2007 from $111 million in the first quarter of 2006, and
down 7% from $121 million in the fourth quarter of 2006.
Total noninterest income decreased $3 million, or 2%, in the first
quarter of 2007 compared with the first quarter of 2006. Global
payment services fees were down $1 million from the first quarter of
2006 and $2 million from the fourth quarter of 2006 as more clients
used compensating balances to pay for services. Financing-related fees
declined sequentially and from the first quarter of 2006 reflecting a
lower level of credit-related fees. Other income increased
sequentially and from a year-ago quarter reflecting higher foreign
exchange and other trading income.
Net interest income decreased slightly compared with the first
quarter of 2006. The sequential-quarter decrease reflects a lower
spread on trading assets and lower volume of noninterest-bearing
deposits. Average deposits were $13.6 billion in the first quarter of
2007, compared with $11.9 billion in the first quarter of 2006 and
$14.5 billion in the fourth quarter of 2006. Average assets were $17.0
billion in the first quarter of 2007, compared with $15.5 billion in
the first quarter of 2006 and $16.6 billion in the fourth quarter of
2006.
Noninterest expense increased $6 million, or 5%, in the first
quarter of 2007 compared with the first quarter of 2006 reflecting
higher salaries and outside help.
23
Other Segment
-------------
Inc/(Dec)
------------------
1Q07 vs. 1Q07 vs.
(In millions) 1Q07 4Q06 3Q06 2Q06 1Q06 4Q06 1Q06
------------------- ------- ------- ------- ------- ------- -------- --------
Noninterest income $ 51 $ 58 $ 31 $ 32 $ 25 $ (7) $ 26
Net interest income 22 37 14 26 25 (15) (3)
------- ------- ------- ------- -------
Total revenue 73 95 45 58 50 (22) 23
Provision for credit losses (12) (9) (2) (2) (6) (3) (6)
Noninterest expense 104 142 145 85 61 (38) 43
------- ------- ------- ------- -------
Income before taxes $ (19) $ (38) $ (98) $ (25) $ (5) 19 (14)
======= ======= ======= ======= =======
Average assets $50,929 $54,499 $49,951 $50,249 $47,710 (3,570) 3,219
Average deposits 7,701 8,147 10,794 10,205 10,761 (446) (3,060)
Income before taxes was a loss of $19 million for the first
quarter of 2007, compared with a loss of $5 million in the first
quarter of 2006, and a loss of $38 million in the fourth quarter of
2006. The loss in the first quarter of 2007 and fourth quarter of 2006
reflected $11 million and $17 million of merger and integration costs
associated with the Acquired Corporate Trust Business.
Total noninterest income increased $26 million, or 104%, in the
first quarter of 2007 compared with the first quarter of 2006
reflecting higher gains in the sponsor fund portfolio and transition
services income. The sequential-quarter decline reflects lower gains in
the sponsor fund portfolio.
Net interest income decreased slightly compared with the first
quarter of 2006. The sequential-quarter decline in net interest income
reflects certain leasing adjustments recorded in the fourth quarter of
2006. Average deposits were $7.7 billion in the first quarter of 2007,
compared with $10.8 billion in the first quarter of 2006 and $8.1
billion in the fourth quarter of 2006. Average assets were $50.9
billion in the first quarter of 2007, compared with $47.7 billion in
the first quarter of 2006 and $54.5 billion in the fourth quarter of
2006.
Provision for credit losses was a credit of $12 million in the
first quarter of 2007, compared with a credit of $6 million in the
first quarter of 2006 and a credit of $9 million the fourth quarter of
2006.
Noninterest expense includes unallocated corporate overhead,
nonrecurring items including merger and integration costs, and certain
expenses previously allocated to the Retail and Middle Market Banking
Segment that are not included in the businesses sold to JPMorgan Chase.
Noninterest expense increased $43 million, or 70%, in the first quarter
of 2007 compared with the first quarter of 2006 primarily reflecting
merger and integration costs, consulting expense, compensation and
benefits. The sequential-quarter decline primarily reflects lower
incentive compensation.
Other items - The tax equivalent adjustment is eliminated in the
Other Segment. Certain revenue and expense items have been driven by
corporate decisions and have been included in the Other Segment. In the
first quarter of 2007 and fourth quarter of 2006, these included merger
and integration costs of $11 million and $17 million associated with
the Acquired Corporate Trust Business.
24
Segment Financial Data
The consolidating schedule below shows the contribution of the Company's
businesses to its overall profitability.
(Dollars in millions)
Subtotal Subtotal
For the Quarter Asset & Clearing & Institut- Total
Ended Asset Wealth Wealth Asset Execution Issuer Treasury ional Continuing
March 31, 2007 Management Management Management Servicing Services Services Services Services Other Operations
--------------- ---------- ---------- --------- --------- -------- -------- -------- ---------- ----- ----------
Noninterest
income $ 101 $ 51 $ 152 $ 471 $ 313 $ 356 $ 132 $ 1,272 $ 51 $ 1,475
Net interest
income 5 15 20 127 59 105 94 385 22 427
--------- -------- -------- ------- -------- -------- -------- ---------- ----- ----------
Total revenue 106 66 172 598 372 461 226 1,657 73 1,902
Provision for
credit losses - - - - - - (3) (3) (12) (15)
Noninterest
expense 65 53 118 424 272 237 117 1,050 104 1,272
--------- -------- -------- ------- -------- -------- -------- ---------- ----- ----------
Income before
taxes $ 41 $ 13 $ 54 $ 174 $ 100 $ 224 $ 112 $ 610 $ (19) $ 645
========= ======== ======== ======= ======== ======== ======== ========== ===== ==========
Operating
margin (1) 39% 20% 31% 29% 27% 49% 50% 37%
Average assets $ 1,387 $ 1,448 $ 2,835 $10,610 $ 16,363 $ 4,235 $ 17,003 $ 48,211 $50,929 $ 101,975(2)
(Dollars in millions)
Subtotal Subtotal
For the Quarter Asset & Clearing & Institut- Total
Ended Asset Wealth Wealth Asset Execution Issuer Treasury ional Continuing
December 31, 2006 Management Management Management Servicing Services Services Services Services Other Operations
----------------- ---------- ---------- --------- --------- -------- -------- -------- ---------- ----- ----------
Noninterest
income $ 109 $ 49 $ 158 $ 421 $ 301 $ 371 $ 132 $ 1,225 $ 58 $ 1,441
Net interest
income 6 14 20 132 62 101 99 394 37 451
--------- -------- -------- ------- -------- -------- -------- ---------- ----- ----------
Total revenue 115 63 178 553 363 472 231 1,619 95 1,892
Provision for
credit losses - - - - 2 (1) (7) (6) (9) (15)
Noninterest
expense 72 51 123 410 257 236 117 1,020 142 1,285
--------- -------- -------- ------- -------- -------- -------- ---------- ----- ----------
Income before
taxes $ 43 $ 12 $ 55 $ 143 $ 104 $ 237 $ 121 $ 605 $ (38) $ 622
========= ======== ======== ======= ======== ======== ======== ========== ===== ==========
Operating
margin (1) 37% 19% 31% 26% 29% 50% 52% 37%
Average assets $ 1,226 $ 1,481 $ 2,707 $ 9,453 $ 14,825 $ 3,988 $ 16,615 $ 44,881 $54,499 $ 102,087(2)
(Dollars in millions)
Subtotal Subtotal
For the Quarter Asset & Clearing & Institut- Total
Ended Asset Wealth Wealth Asset Execution Issuer Treasury ional Continuing
September 30, 2006 Management Management Management Servicing Services Services Services Services Other Operations
------------------ ---------- ---------- --------- --------- -------- -------- -------- ---------- ----- ----------
Noninterest
income $ 84 $ 47 $ 131 $ 424 $ 331 $ 205 $ 141 $ 1,101 $ 31 $ 1,263
Net interest
income 3 16 19 117 58 47 96 318 14 351
--------- -------- -------- ------- -------- -------- -------- ---------- ----- ----------
Total revenue 87 63 150 541 389 252 237 1,419 45 1,614
Provision for
credit losses - - - - - 1 (3) (2) (2) (4)
Noninterest
expense 57 51 108 400 306 122 115 943 145 1,196
--------- -------- -------- ------- -------- -------- -------- ---------- ----- ----------
Income before
taxes $ 30 $ 12 $ 42 $ 141 $ 83 $ 129 $ 125 $ 478 $ (98) $ 422
========= ======== ======== ======= ======== ======== ======== ========== ===== ==========
Operating
margin (1) 34% 19% 28% 26% 21% 51% 53% 34%
Average assets $ 1,082 $ 1,503 $ 2,585 $ 8,641 $ 16,363 $ 1,359 $ 16,680 $ 43,043 $49,951 $ 95,579(2)
25
(Dollars in millions)
Subtotal Subtotal
For the Quarter Asset & Clearing & Institut- Total
Ended Asset Wealth Wealth Asset Execution Issuer Treasury ional Continuing
June 30, 2006 Management Management Management Servicing Services Services Services Services Other Operations
------------------ ---------- ---------- --------- --------- -------- -------- -------- ---------- ----- ----------
Noninterest
income $ 85 $ 51 $ 136 $ 471 $ 355 $ 220 $ 156 $ 1,202 $ 32 $ 1,370
Net interest
income 3 13 16 113 54 52 97 316 26 358
--------- -------- -------- ------- -------- -------- -------- ---------- ----- ----------
Total revenue 88 64 152 584 409 272 253 1,518 58 1,728
Provision for
credit losses - (2) (2) - (4) - 7 3 (2) (1)
Noninterest
expense 54 51 105 399 307 122 120 948 85 1,138
--------- -------- -------- ------- -------- -------- -------- ---------- ----- ----------
Income before
taxes $ 34 $ 15 $ 49 $ 185 $ 106 $ 150 $ 126 $ 567 $ (25) $ 591
========= ======== ======== ======= ======== ======== ======== ========== ===== ==========
Operating
margin (1) 39% 23% 32% 32% 26% 55% 50% 37%
Average assets $ 1,055 $ 1,446 $ 2,501 $ 8,873 $ 17,175 $ 1,316 $ 16,279 $ 43,643 $50,249 $ 96,393(2)
(Dollars in millions)
Subtotal Subtotal
For the Quarter Asset & Clearing & Institut- Total
Ended Asset Wealth Wealth Asset Execution Issuer Treasury ional Continuing
March 31, 2006 Management Management Management Servicing Services Services Services Services Other Operations
------------------ ---------- ---------- --------- --------- -------- -------- -------- ---------- ----- ----------
Noninterest
income $ 79 $ 51 $ 130 $ 424 $ 386 $ 165 $ 135 $ 1,110 $ 25 $ 1,265
Net interest
income 2 16 18 103 53 45 95 296 25 339
--------- -------- -------- ------- -------- -------- -------- ---------- ----- ----------
Total revenue 81 67 148 527 439 210 230 1,406 50 1,604
Provision for
credit losses - - - - (2) - 8 6 (6) -
Noninterest
expense 49 52 101 383 303 110 111 907 61 1,069
--------- -------- -------- ------- -------- -------- -------- ---------- ----- ----------
Income before
taxes $ 32 $ 15 $ 47 $ 144 $ 138 $ 100 $ 111 $ 493 $ (5) $ 535
========= ======== ======== ======= ======== ======== ======== ========== ===== ==========
Operating
margin (1) 40% 22% 32% 27% 31% 48% 48% 35%
Average assets $ 925 $ 1,525 $ 2,450 $ 7,418 $ 17,381 $ 1,351 $ 15,521 $ 41,671 $47,710 $ 91,831(2)
(1) Income before taxes divided by total revenue.
(2) Including average assets of discontinued operations of $66 million, $51 million,
$13,285 million, $13,993 million, and $14,302 million for the quarters
ended March 31, 2007, December 31, 2006, September 30, 2006, June 30, 2006
and March 31, 2006, consolidated average assets were $102,041 million,
$102,138 million, $108,864 million, $110,386 million and $106,133 million
for the quarters ended March 31, 2007, December 31, 2006, September 30,
2006, June 30, 2006, and March 31, 2006.
26
CRITICAL ACCOUNTING POLICIES
The Company's significant accounting policies are described in the
"Notes to Consolidated Financial Statements" under "Summary of Significant
Accounting and Reporting Policies" in the Company's 2006 Annual Report on
Form 10-K. Four of the Company's more critical accounting policies are
those related to the allowance for credit losses, the valuation of
derivatives and securities where quoted market prices are not available,
goodwill and other intangibles, and pension accounting.
Allowance for Credit Losses
---------------------------
The allowance for credit losses and allowance for lending-related
commitments consist of four elements: (1) an allowance for impaired
credits; (2) an allowance for higher risk rated loans and exposures; (3) an
allowance for pass rated loans and exposures; and (4) an unallocated
allowance based on general economic conditions and certain risk factors in
the Company's individual portfolio and markets. Further discussion on the
four elements can be found under "Consolidated Balance Sheet Review" in the
MD&A section.
The allowance for credit losses represents management's estimate of
probable losses inherent in the Company's credit portfolio. This
evaluation process is subject to numerous estimates and judgments.
Probability of default ratings are assigned after analyzing the credit
quality of each borrower/counterparty and the Company's internal ratings
are generally consistent with external ratings agency's default databases.
Loss given default ratings are driven by the collateral, structure, and
seniority of each individual asset and are consistent with external loss
given default/recovery databases. The portion of the allowance related to
impaired credits is based on the present value of future cash flows.
Changes in the estimates of probability of default, risk ratings, loss
given default/recovery rates, and cash flows could have a direct impact on
the allocated allowance for loan losses.
To the extent actual results differ from forecasts or management's
judgment, the allowance for credit losses may be greater or less than
future charge-offs.
The Company considers it difficult to quantify the impact of changes
in forecast on its allowance for credit losses. Nevertheless, the Company
believes the following discussion may enable investors to better understand
the variables that drive the allowance for credit losses.
A key variable in determining the allowance is management's judgment
in determining the size of the unallocated allowance. At March 31, 2007,
the unallocated allowance was 27% of the total allowance. If the
unallocated allowance were five percent higher or lower, the allowance
would have increased or decreased by $21 million, respectively.
The credit rating assigned to each credit is another significant
variable in determining the allowance. If each credit were rated one grade
better, the allowance would have decreased by $72 million, while if each
credit were rated one grade worse, the allowance would have increased by
$123 million.
Similarly, if the loss given default were one rating worse, the
allowance would have increased by $34 million, while if the loss given
default were one rating better, the allowance would have decreased by $42
million.
For impaired credits, if the fair value of the loans were 10% higher
or lower, the allowance would have decreased or increased by $1 million,
respectively.
27
Valuation of Derivatives and Securities Where Quoted Market Prices Are Not
--------------------------------------------------------------------------
Available
---------
When quoted market prices are not available for derivatives and
securities values, such values are determined at fair value, which is
defined as the value at which positions could be closed out or sold in a
transaction with a willing counterparty over a period of time consistent
with the Company's trading or investment strategy. Fair value for these
instruments is determined based on discounted cash flow analysis,
comparison to similar instruments, and the use of financial models.
Financial models use as their basis independently-sourced market parameters
including, for example, interest rate yield curves, option volatilities,
and currency rates. Discounted cash flow analysis is dependent upon
estimated future cash flows and the level of interest rates. Model-based
pricing uses inputs of observable prices for interest rates, foreign
exchange rates, option volatilities and other factors. Models are
benchmarked and validated by independent parties. The Company's valuation
process takes into consideration factors such as counterparty credit
quality, liquidity and concentration concerns. The Company applies
judgment in the application of these factors. In addition, the Company
must apply judgment when no external parameters exist. Finally, other
factors can affect the Company's estimate of fair value including market
dislocations, incorrect model assumptions, and unexpected correlations.
These valuation methods could expose the Company to materially
different results should the models used or underlying assumptions be
inaccurate. See "Use of Estimates" in "Summary of Significant Accounting
and Reporting Policies" of the Notes to Consolidated Financial Statement in
the Company's 2006 Annual Report on Form 10-K.
To assist in assessing the impact of a change in valuation, at March
31, 2007, approximately $1.9 billion of the Company's portfolio of
securities and derivatives is not priced based on quoted market prices
because no such quoted market prices are available. A change of 2.5% in
the valuation of these securities and derivatives would result in a change
in pre-tax income of $49 million.
Goodwill and Other Intangibles
------------------------------
The Company records all assets and liabilities acquired in purchase
acquisitions, including goodwill, indefinite-lived intangibles, and other
intangibles, at fair value as required by FASB Statements No. 141 and No.
142 ("SFAS 141" and "SFAS 142"), "Business Combinations" and "Goodwill and
Other Intangible Assets." Goodwill ($5,131 million at March 31, 2007) and
indefinite-lived intangible assets ($370 million at March 31, 2007) are not
amortized but are subject to annual tests for impairment or more often if
events or circumstances indicate they may be impaired. Other intangible
assets are amortized over their estimated useful lives and are subject to
impairment if events or circumstances indicate a possible inability to
realize the carrying amount. The initial recording of goodwill,
indefinite-lived intangibles, and other intangibles requires subjective
judgments concerning estimates of the fair value of acquired assets. The
goodwill impairment test is performed in two phases. The first step of the
goodwill impairment test compares the fair value of the reporting unit with
its carrying amount, including goodwill. If the fair value of the
reporting unit exceeds its carrying amount, goodwill of the reporting unit
is considered not impaired; however, if the carrying amount of the
reporting unit exceeds its fair value, an additional procedure must be
performed. That additional procedure compares the implied fair value of
the reporting unit's goodwill with the carrying amount of that goodwill.
An impairment loss is recorded to the extent that the carrying amount of
goodwill exceeds its implied fair value. Indefinite-lived intangible
assets are evaluated for impairment at least annually by comparing their
fair value to their carrying value. Other intangible assets ($1,077
million at March 31, 2007) are evaluated for impairment if events and
circumstances indicate a possible impairment. Such evaluation of other
intangible assets is based on undiscounted cash flow projections. The
Company
28
recorded a $6 million impairment charge in 2006 related to the
write-off of customer intangibles in Europe.
Fair value may be determined using: market prices, comparison to
similar assets, market multiples, discounted cash flow analysis and other
determinates. Estimated cash flows may extend far into the future and, by
their nature, are difficult to determine over an extended timeframe.
Factors that may significantly affect the estimates include, among others,
competitive forces, customer behaviors and attrition, changes in revenue
growth trends, cost structures and technology, and changes in discount
rates and specific industry or market sector conditions. Other key
judgments in accounting for intangibles include useful life and
classification between goodwill and indefinite-lived intangibles or other
intangibles that require amortization. See Note "Goodwill and Intangibles"
in the Notes to Consolidated Financial Statements for additional
information regarding intangible assets.
To assist in assessing the impact of a goodwill, indefinite-lived
intangibles, or other intangible asset impairment charge, at March 31,
2007, the Company has $6.6 billion of goodwill, indefinite-lived
intangibles, and other intangible assets. The impact of a 5% impairment
charge would result in reduction in pre-tax income of approximately $329
million.
Pension Accounting
------------------
The Company has defined benefit pension plans covering approximately
14,200 U.S. employees and approximately 2,750 non-US employees.
The Company has three defined benefit pension plans in the U.S. and
six overseas. The U.S. plans account for 77% of the projected benefit
obligation. Pension expense was $38 million in 2006, compared with $26
million in 2005 and a pension credit of $24 million in 2004. In addition
to its pension plans, the Company also has an Employee Stock Ownership Plan
("ESOP") which may provide additional benefits to certain employees. Upon
retirement, covered employees are entitled to the higher of their benefit
under the ESOP or the defined benefit plan. If the benefit is higher under
the defined benefit plan, the employees' ESOP account is contributed to the
pension plan.
A number of key assumption and measurement date values determine
pension expense. The key elements include the long-term rate of return on
plan assets, the discount rate, the market-related value of plan assets,
and for the primary U.S. plan the price used to value stock in the ESOP.
Since 2004, these key elements have varied as follows:
2007 2006 2005 2004
-------- -------- -------- --------
(Dollars in millions,
except per share amounts)
Domestic plans:
Long-term rate of return
on plan assets 8.00% 7.88% 8.25% 8.75%
Discount rate 6.00 5.88 6.00 6.25
Market-related value of
plan assets(1) $ 1,352 $ 1,324 $ 1,502 $ 1,523
ESOP stock price(1) 34.85 30.46 30.67 27.88
Net U.S. pension credit/ (expense) $ (26) $ (17) $ 31
All other pension credit/ (expense) (12) (9) (7)
-------- -------- --------
Total pension credit/ (expense)(2) $ (38) $ (26) $ 24
======== ======== ========
(1) Actuarially smoothed data. See "Summary of Significant Accounting
and Reporting Policies" in Notes to Consolidated Financial
Statements in the 2006 Annual Report on Form 10-K.
(2) Pension benefits expense includes discontinued operations expense
of $6 million in 2006, 2005, and 2004.
29
The discount rate for U.S. pension plans was determined after
reviewing a number of high quality long-term bond indices whose yields were
adjusted to match the duration of the Company's pension liability. The
Company also reviewed the results of several models that matched bonds to
the Company's pension cash flows. The various indices and models produced
discount rates ranging from 5.91% to 6.10%. After reviewing the various
indices and models the Company selected a discount rate of 6.00%. The
discount rates for foreign pension plans are based on high quality
corporate bonds rates in countries that have an active corporate bond
market. In those countries with no active corporate bond market, discount
rates are based on local government bond rates plus a credit spread.
The Company's expected long-term rate of return on plan assets is
based on anticipated returns for each asset class. For 2007 and 2006, the
assumptions for the long-term rates of return on plan assets were 8.00% and
7.88%, respectively. Anticipated returns are weighted for the target
allocation for each asset class. Anticipated returns are based on
forecasts for prospective returns in the equity and fixed-income markets,
which should track the long-term historical returns for these markets. The
Company also considers the growth outlook for U.S. and global economies, as
well as current and prospective interest rates.
The market-related value of plan assets also influences the level of
pension expense. Differences between expected and actual returns are
recognized over five years to compute an actuarially derived market-related
value of plan assets. In 2006, the market-related value of plan assets
declined as the extraordinary actual return in 2000 was replaced with a
more modest return. The market-related value of plan assets grew slightly
for 2007 as the pension fund earned more normal returns.
Unrecognized actuarial gains and losses are amortized over the future
service period (11 years) of active employees if they exceed a threshold
amount. The Company currently has unrecognized losses which are being
amortized.
For 2006, U.S. pension expense increased by $9 million reflecting
changes in assumptions, the amortization of unrecognized pension losses,
and a decline in the market-related value of plan assets, partly offset by
a switch to the computation of benefits from final average pay to career
average pay. U.S. pension expense is expected to decline approximately $30
million in 2007 primarily due to employees working longer and the Pension
Protection Act of 2006.
The annual impacts on the primary U.S. plan of hypothetical changes
in the key elements on the pension expense are shown in the tables below.
(Dollars in millions, Increase in Decrease in
except per share amounts) Pension Expense 2007 Base Pension Expense
--------------- ------------- ---------------
Long-term rate of return
on plan assets 7.00% 7.50% 8.00% 8.50% 9.00%
Change in pension expense $ 18.4 $ 9.2 N/A $ 9.2 $ 18.4
Discount rate 5.50% 5.75% 6.00% 6.25% 6.50%
Change in pension expense $ 11.8 $ 5.8 N/A $ 5.7 $ 11.2
Market-related value of
plan assets -20.00% -10.00% $1,352 +10.00% +20.00%
Change in pension expense $ 50.6 $ 25.3 N/A $ 25.2 $ 46.9
ESOP stock price $24.85 $29.85 $34.85 $39.85 $44.85
Change in pension expense $ 14.5 $ 7.0 N/A $ 6.5 $ 12.5
30
CONSOLIDATED BALANCE SHEET REVIEW
Total assets were $99.8 billion at March 31, 2007, compared with
$103.6 billion at March 31, 2006 and $103.4 billion at December 31, 2006.
The decrease in assets from March 31, 2006 primarily reflects the sale of
the Retail Business and decline in trading assets partly offset by
increases in short-term high quality interest-bearing deposits in banks and
loans to financial institutions. Total shareholders' equity was $11.5
billion at March 31, 2007, compared with $10.1 billion at March 31, 2006
and $11.6 billion at December 31, 2006.
On a continuing operations basis, return on average common equity for
the first quarter of 2007 was 15.70%, (16.06% excluding merger and
integration costs) compared with 14.75% in the first quarter of 2006 and
14.95% in the fourth quarter of 2006 (15.36% excluding merger and
integration costs).
On a continuing operations basis, return on average assets for the
first quarter of 2007 was 1.73%, (1.78% excluding merger and integration
costs) compared with 1.50% in the first quarter of 2006 and 1.66% in the
fourth quarter of 2006 (1.70% excluding merger and integration costs).
Investment Securities
---------------------
The table below shows the distribution of the Company's securities
portfolio:
Investment securities (at fair value)
(In millions) 3/31/07 12/31/06
---------- ----------
Fixed income securities:
Mortgage-backed securities $ 20,890 $ 17,785
Asset-backed securities 436 464
Corporate debt 284 256
Short-term money market instruments 522 531
U.S. treasury securities 86 86
U.S. government agencies 673 673
State and political subdivisions 82 88
Emerging market debt (collateralized
by U.S. treasury zero coupon obligations) 116 116
Other foreign debt 10 10
---------- ----------
Subtotal fixed income securities 23,099 20,009
Equity securities:
Money market or fixed income funds 504 1,032
Other 78 46
---------- ----------
Subtotal equity securities 582 1,078
---------- ----------
Total investment securities $ 23,681 $ 21,087
========== ==========
Total investment securities were $23.7 billion at March 31, 2007,
compared with $27.1 billion at March 31, 2006, and $21.1 billion at
December 31, 2006. Average investment securities were $22.4 billion in the
first quarter of 2007, compared with $23.2 billion in the first quarter of
2006 and $20.7 billion in the fourth quarter of 2006. The Company's
portfolio of highly rated mortgage-backed securities are 86% rated AAA, 10%
AA, and 4% A. In replacing securities that mature or are paid off, the
Company has been adding either adjustable or short life classes of
structured mortgage-backed securities, both of which have short durations.
The effective duration of the Company's mortgage portfolio at March 31,
2007 was approximately 1.74 years.
Unrealized net loss on securities available-for-sale was $1 million at
March 31, 2007, compared with unrealized net losses of $195 million at
March 31, 2006, and no unrealized net gain or loss at December 31, 2006.
The asymmetrical accounting treatment of the impact of a change in interest
rates
31
on the Company's balance sheet may create a situation in which an
increase in interest rates can adversely affect reported equity and
regulatory capital, even though economically there may be no impact on the
economic capital position of the Company. For example, an increase in
rates will result in a decline in the value of the fixed-rate portion of
the Company's fixed income investment portfolio, which will be reflected
through a reduction in other comprehensive income in the Company's
shareholders' equity, thereby affecting the tangible common equity ("TCE")
ratio. Under current accounting rules, there is no corresponding change in
value of the Company's fixed-rate liabilities, even though economically
these liabilities are more valuable as rates rise.
Loans
-----
(In billions)
Quarterly
Period End Average
------------------------- -------------------------
Total Non-Margin Margin Total Non-Margin Margin
----- ---------- ------ ----- ---------- ------
March 31, 2007 $38.3 $33.2 $5.1 $36.0 $30.6 $5.4
December 31, 2006 37.8 32.7 5.1 35.3 30.1 5.2
March 31, 2006 32.2 26.9 5.3 31.8 26.1 5.7
Total loans were $38.3 billion at March 31, 2007, compared with $37.8
billion at December 31, 2006. The increase in total loans from December
31, 2006 primarily reflects increased lending to financial institutions.
Average total loans were $36.0 billion in the first quarter of 2007,
compared with $31.8 billion in the first quarter of 2006. The increase in
average loans from March 31, 2006 results from increased lending to
financial institutions and purchases of residential mortgage loans.
The following tables provide additional details on the Company's
credit exposures and outstandings for continuing operations at March 31,
2007 in comparison to December 31, 2006.
Overall Loan Portfolio
----------------------
March 31, 2007 December 31, 2006
---------------------------- ----------------------------
Unfunded Total Unfunded Total
(In billions) Loans Commitments Exposure Loans Commitments Exposure
---------------------------- ----------------------------
Financial institutions $ 18.3 $ 27.1 $ 45.4 $ 17.4 $ 27.5 $ 44.9
Corporate 4.2 20.0 24.2 4.1 19.8 23.9
-------- -------- -------- -------- -------- --------
22.5 47.1 69.6 21.5 47.3 68.8
-------- -------- -------- -------- -------- --------
Consumer 4.3 0.5 4.8 4.3 0.5 4.8
Leasing financings 4.9 0.1 5.0 5.5 0.1 5.6
Commercial real estate 1.5 1.2 2.7 1.4 1.4 2.8
Margin loans 5.1 - 5.1 5.1 - 5.1
-------- -------- -------- -------- -------- --------
Total $ 38.3 $ 48.9 $ 87.2 $ 37.8 $ 49.3 $ 87.1
======== ======== ======== ======== ======== ========
32
Financial Institutions
----------------------
The financial institutions portfolio exposure was $45.4 billion at
March 31, 2007, compared to $44.9 billion at December 31, 2006. The
increase in exposure from year-end 2006 reflects greater activity in the
capital markets in the first quarter of 2007, which drove increased demands
for credit from financial institutions. These exposures are of high
quality with 87% meeting the investment grade criteria of the Company's
rating system. These exposures are generally short-term, with 77% expiring
within one year and are frequently secured. For example, mortgage banking,
securities industry, and investment managers often borrow against
marketable securities held in custody at the Company. The diversity of the
portfolio is shown in the accompanying table:
(In billions)
March 31, 2007 December 31, 2006
--------------------------------------- ---------------------------
Unfunded Total %Inv %due Unfunded Total
Lending Division Loans Commitments Exposures Grade <1 Yr Loans Commitments Exposures
------------------- ----- ----------- --------- ----- ----- ----- ----------- ---------
Banks $ 7.2 $ 5.4 $ 12.6 73% 86% $ 5.7 $ 5.5 $ 11.2
Securities industry 5.5 4.7 10.2 86 96 6.0 5.4 11.4
Insurance 0.4 6.0 6.4 100 43 0.6 6.1 6.7
Government 0.1 7.2 7.3 100 64 0.1 6.7 6.8
Asset managers 4.8 2.0 6.8 86 86 4.7 1.9 6.6
Mortgage banks 0.2 0.7 0.9 72 49 0.2 0.7 0.9
Endowments 0.1 1.1 1.2 100 59 0.1 1.2 1.3
----- ----------- --------- ----- ----- ----- ----------- ---------
Total $18.3 $ 27.1 $ 45.4 87% 77% $17.4 $ 27.5 $ 44.9
===== =========== ========= ===== ===== ===== =========== =========
Corporate
---------
The corporate portfolio exposure increased to $24.2 billion at March
31, 2007 from $23.9 billion at year-end 2006. Approximately 75% of the
portfolio is investment grade while 15% of the portfolio matures within one
year.
(In billions)
March 31, 2007 December 31, 2006
--------------------------------------- ---------------------------
Unfunded Total %Inv %due Unfunded Total
Lending Division Loans Commitments Exposures Grade <1 Yr Loans Commitments Exposures
------------------- ----- ----------- --------- ----- ----- ----- ----------- ---------
Media $ 0.9 $ 1.7 $ 2.6 73% 6% $ 1.2 $ 2.0 $ 3.2
Cable 0.2 0.3 0.5 74 - 0.2 0.4 0.6
Telecom - 0.4 0.4 85 - - 0.3 0.3
----- ----------- -------- ------ ----------- ---------
Subtotal 1.1 2.4 3.5 74 5 1.4 2.7 4.1
Energy 0.7 5.2 5.9 83 6 0.6 5.0 5.6
Retailing 0.1 2.8 2.9 88 41 0.1 2.3 2.4
Automotive (1) 0.1 1.0 1.1 56 35 0.1 1.0 1.1
Healthcare 0.4 1.5 1.9 80 11 0.5 1.8 2.3
Other (2) 1.8 7.1 8.9 67 14 1.4 7.0 8.4
----- ----------- --------- ----- ----- ----- ----------- ---------
Total $ 4.2 $ 20.0 $ 24.2 75% 15% $ 4.1 $ 19.8 $ 23.9
===== =========== ========= ===== ===== ===== =========== =========
(1) During the third quarter of 2005, the Company eliminated the Automotive division and
transferred the customers to the other geographic lending divisions. The amounts
in the table were constructed for analytical purposes.
(2) Diversified portfolio of industries and geographies.
The Company continues to seek to selectively reduce automotive
exposures given ongoing weakness in the domestic automotive industry.
Total exposures reported in the Automotive Division were down $11 million
at March 31, 2007 compared with December 31, 2006. At March 31, 2007, this
broadly defined industry portfolio consisted of exposures of $188 million
to Big Three automotive manufacturing companies, $158 million to finance
subsidiaries, $378 million to highly rated asset-backed securitization
vehicles, $246 million to suppliers, and $141 million of other.
The Company's exposure to the airline industry, at March 31, 2007,
consisted of a $294 million leasing portfolio, including a $17 million real
estate lease exposure. At March 31, 2007, the airline-leasing portfolio
33
consisted of $91 million to major U.S. carriers, $141 million to foreign
airlines and $62 million to U.S. regionals.
During the first quarter of 2007, the airline industry continued to
face difficult operating conditions. The industry's excess capacity and
higher oil prices continued to have a dampening effect on aircraft values
in the secondary market. Because of these factors, the Company continues to
maintain a sizable allowance for loan losses against these exposures and to
closely monitor the portfolio.
Counterparty Risk Ratings Profile
---------------------------------
The table below summarizes the risk ratings of the Company's foreign
exchange and interest rate derivative counterparty credit exposure for the
past year.
For the Quarter Ended
--------------------------------------------------
Rating(1) 3/31/07 12/31/06 9/30/06 6/30/06 3/31/06
--------------------- --------------------------------------------------
AAA to AA- 75% 76% 77% 77% 77%
A+ to A- 13 12 10 10 8
BBB+ to BBB- 6 6 7 6 9
Noninvestment Grade 6 6 6 7 6
-------- --------- ---------- --------- ----------
Total 100% 100% 100% 100% 100%
======== ========= ========== ========= ==========
(1) Represents credit rating agency equivalent of internal credit ratings.
Nonperforming Assets
--------------------
Change Percent
3/31/2007 vs. Inc/
(Dollars in millions) 3/31/2007 12/31/2006 12/31/2006 (Dec)
--------- ---------- ----------- -------
Loans:
Commercial $ 18 $ 28 $ (10) (36)%
Foreign 9 9 - -
--------- ---------- -----------
Total nonperforming loans 27 37 (10) (27)
Other assets owned 2 1 1 100
--------- ---------- -----------
Total nonperforming assets $ 29 $ 38 $ (9) (24)
========= ========== ===========
Nonperforming assets ratio 0.1% 0.1%
Allowance for loan
losses/nonperforming loans 1,074.1 775.7
Allowance for loan
losses/nonperforming assets 1,000.0 755.3
Total allowance for credit
losses/nonperforming loans 1,574.1 1,181.1
Total allowance for credit
losses/nonperforming assets 1,465.5 1,150.0
The sequential-quarter decrease in nonperforming assets primarily
reflects a paydown of a loan to an auto parts supplier.
34
Activity in Nonperforming Assets
(In millions) Quarter End Quarter End
March 31, 2007 December 31, 2006
------------------ ------------------
Balance at beginning of period $ 38 $ 38
Additions 10 8
Charge-offs - (2)
Paydowns/Sales (19) (6)
------------------ ------------------
Balance at end of period $ 29 $ 38
================== ==================
Interest income would have been increased by $0.5 million and $0.4
million for the first quarters of 2007 and 2006 if loans on nonaccrual
status at March 31, 2007 and 2006 had been performing for the entire
period.
Impaired Loans
--------------
The table below sets forth information about the Company's impaired
loans. The Company uses the discounted cash flow, collateral value, or
market price methods for valuing its impaired loans:
March 31, December 31, March 31,
(In millions) 2007 2006 2006
------------ ------------ -----------
Impaired loans with an allowance $ 17 $ 8 $ 17
Impaired loans without an allowance(1) - 19 -
------------ ------------ -----------
Total impaired loans $ 17 $ 27 $ 17
============ ============ ===========
Allowance for impaired loans(2) $ 2 $ 1 $ 4
Average balance of impaired loans
during the quarter 25 22 17
Interest income recognized on
impaired loans during the quarter 0.1 0.5 -
(1) When the discounted cash flows, collateral value or market price equals
or exceeds the carrying value of the loan, then the loan does not require
an allowance under the accounting standard related to impaired loans.
(2) The allowance for impaired loans is included in the Company's allowance
for credit losses.
35
Allowance
---------
March 31, December 31, March 31,
(Dollars in millions) 2007 2006 2006
------------ ------------ ------------
Margin loans $ 5,133 $ 5,167 $ 5,312
Non-margin loans 33,156 32,626 26,879
------------ ------------ ------------
Total loans $ 38,289 $ 37,793 $ 32,191
============ ============ ============
Allowance for loan losses $ 290 $ 287 $ 334
Allowance for lending-related
commitments 135 150 140
------------ ------------ ------------
Total allowance for
credit losses $ 425 $ 437 $ 474
============ ============ ============
Allowance for loan losses
as a percent of total loans 0.76% 0.76% 1.04%
Allowance for loan losses
as a percent of non-margin loans 0.87 0.88 1.24
Total allowance for credit losses
as a percent of total loans 1.11 1.16 1.47
Total allowance for credit losses
as a percent of non-margin loans 1.28 1.34 1.76
The total allowance for credit losses was $425 million, or 1.11% of
total loans at March 31, 2007, compared with $474 million, or 1.47% of
total loans at March 31, 2006 and $437 million, or 1.16% of total loans at
December 31, 2006. The decline in the allowance from the first quarter of
2006 reflects the continued strong credit quality of the Company's loan
portfolio.
The Company has $5.1 billion of secured margin loans on its balance
sheet at March 31, 2007. The Company has rarely suffered a loss on these
types of loans and does not allocate any of its allowance for credit losses
to these loans. As a result, the Company believes the ratio of total
allowance for credit losses to non-margin loans is a more appropriate
metric to measure the adequacy of the reserve.
The ratio of the total allowance for credit losses to non-margin loans
was 1.28% at March 31, 2007, compared with 1.76% at March 31, 2006 and
1.34% at December 31, 2006, reflecting improvement in the credit quality
since the first quarter of 2006. The ratio of the allowance for loan losses
to nonperforming assets was 1,000% at March 31, 2007, compared with 1,336%
at March 31, 2006, and 755.3% at December 31, 2006.
The allowance for loan losses and the allowance for lending-related
commitments consists of four elements: (1) an allowance for impaired
credits (nonaccrual commercial credits over $1 million), (2) an allowance
for higher risk rated credits, (3) an allowance for pass rated credits, and
(4) an unallocated allowance based on general economic conditions and risk
factors in the Company's individual markets.
The first element, impaired credits, is based on individual analysis
of all nonperforming commercial credits over $1 million. The allowance is
measured by the difference between the recorded value of impaired loans and
their fair value. Fair value is either the present value of the expected
future cash flows from borrower, the market value of the loan, or the fair
value of the collateral.
The second element, higher risk rated credits, is based on the
assignment of loss factors for each specific risk category of higher risk
credits. The Company rates each credit in its portfolio that exceeds $1
million and assigns the credits to specific risk pools. A potential loss
factor is assigned to each pool, and an amount is included in the allowance
equal to the product of the amount of the loan in the pool and the risk
factor. Reviews of higher risk
36
rated loans are conducted quarterly and the loan's rating is updated as
necessary. The Company prepares a loss migration analysis and compares
its actual loss experience to the loss factors on an annual basis to attempt
to ensure the accuracy of the loss factors assigned to each pool.
The third element, pass rated credits, is based on the Company's
expected loss model. Borrowers are assigned to pools based on their credit
ratings. The expected loss for each loan in a pool incorporates the
borrower's credit rating, loss given default rating and maturity. The
credit rating is dependent upon the borrower's probability of default. The
loss given default incorporates a recovery expectation. Borrower ratings
are reviewed semi-annually at a minimum and are periodically mapped to
third party, including rating agency and default and recovery, data bases
to ensure ongoing consistency and validity. Commercial loans over $1
million are individually analyzed before being assigned a credit rating.
The Company also applies this technique to its leasing and consumer
portfolios.
The fourth element, the unallocated allowance, is based on
management's judgment regarding the following factors:
* Economic conditions including duration of the current cycle;
* Past experience including recent loss experience;
* Credit quality trends;
* Collateral values;
* Volume, composition, and growth of the loan portfolio;
* Specific credits and industry conditions;
* Results of bank regulatory and internal credit exams;
* Actions by the Federal Reserve Board;
* Delay in receipt of information to evaluate loans or confirm existing
credit deterioration; and
* Geopolitical issues and their impact on the economy.
Based on an evaluation of these four elements, including individual
credits, historical credit losses, and global economic factors, the Company
has allocated its allowance for credit losses on a continuing operations
basis as follows:
March 31, December 31,
2007 2006
------------ -----------
Domestic
Real Estate 2% 2%
Commercial 64 67
Consumer 6 6
Foreign 1 2
Unallocated 27 23
------------ -----------
100% 100%
============ ===========
Such an allocation is inherently judgmental, and the entire allowance
for credit losses is available to absorb credit losses regardless of the
nature of the loss.
The unallocated allowance increase in the first quarter of 2007
reflects various factors in the current credit environment, including
potential spillover into other credit markets from the distress in the sub-
prime mortgage markets.
37
Deposits
--------
Total deposits were $59.0 billion at March 31, 2007, compared with
$50.8 billion at March 31, 2006, and $62.1 billion at December 31, 2006.
The increase from March 31, 2006 was primarily due to growth in the
securities servicing businesses and the Acquired Corporate Trust Business.
The sequential-quarter decline was primarily due to lower customer activity
levels, which resulted in a reduced level of customer deposits at quarter
end. Noninterest-bearing deposits were $17.3 billion at March 31, 2007,
compared with $19.5 billion at December 31, 2006. Interest-bearing
deposits were $41.7 billion at March 31, 2007, compared with $42.6 billion
at December 31, 2006.
LIQUIDITY
The Company maintains its liquidity through the management of its
assets and liabilities, utilizing worldwide financial markets. The
diversification of liabilities reflects the Company's efforts to maintain
flexibility of funding sources under changing market conditions. Stable
core deposits from the Company's securities servicing businesses and asset
management and wealth management businesses are generated through the
Company's diversified network and managed with the use of trend studies and
deposit pricing. The use of derivative products such as interest rate swaps
and financial futures enhances liquidity by enabling the Company to issue
long-term liabilities with limited exposure to interest rate risk.
Liquidity also results from the maintenance of a portfolio of assets which
can be easily sold and the monitoring of unfunded loan commitments, thereby
reducing unanticipated funding requirements. Liquidity is managed on both a
consolidated basis and at The Bank of New York Company, Inc. parent company
("Parent").
On a continuing operations basis, non-core sources of funds such as
money market rate accounts, certificates of deposits greater than $100,000,
federal funds purchased, and other borrowings were $12.7 billion and $13.6
billion on an average basis for the first three months of 2007 and 2006.
Average foreign deposits, primarily from the Company's European-based
securities servicing business, were $33.6 billion and $30.2 billion for the
first three months of 2007 and 2006. The increase in foreign deposits
reflects greater liquidity from the Company's corporate trust and custody
businesses. Domestic savings and other time deposits were $1.0 billion on
an average basis for the first three months of 2007 compared to $1.4
billion in 2006. Average payables to customers and broker-dealers decreased
to $4.7 billion from $5.2 billion in 2006. The decline in payables to
customers and broker-dealers primarily reflects lower customer balances and
loss of a significant customer at Pershing. Long-term debt averaged $8.9
billion and $8.0 billion for the first three months of 2007 and 2006,
respectively. The increase in long-term debt reflects the building of
liquidity to pay debt maturing in 2007. A significant reduction in the
Company's securities servicing businesses would reduce its access to
deposits. Noninterest-bearing deposits increased to $14.9 billion from
$10.1 billion in the first quarter of 2006, reflecting organic growth in
securities servicing businesses and the acquisition of the Acquired
Corporate Trust Business.
The Company's transaction with JPMorgan Chase altered the composition
of the balance sheet. When the Acquired Corporate Trust Business is fully
integrated in 2007, approximately $14 billion of U.S. dollar retail
deposits will have been replaced with between $11 billion and $14 billion
of institutional corporate trust deposits. Between $7 billion and $10
billion of deposits related to the Acquired Corporate Trust Business have
not yet transitioned to the Company. These deposits will transition to the
Company as regulatory approval is received to operate in certain foreign
locations and as the novation process proceeds in other foreign locations.
The Company expects the transition will be substantially complete by June
30, 2007. Until the transition is complete, JPMorgan Chase will pay the
Company for the net economic value of these deposits. In the first quarter
of 2007, the Company recorded $25 million of net economic value payments in
noninterest income. On the asset side of the balance sheet, approximately
$8 billion of retail and
38
middle market loans sold to JPMorgan Chase have been replaced with liquid
assets and securities.
The Parent has four major sources of liquidity: dividends from its
subsidiaries, the commercial paper market, a revolving credit agreement
with third party financial institutions, and access to the capital markets.
At March 31, 2007, the Bank can pay dividends of approximately $888
million to the Parent without the need for regulatory waiver. This
dividend capacity would increase in the remainder of 2007 to the extent of
the Bank's net income less dividends. Nonbank subsidiaries of the Parent
have liquid assets of approximately $244 million. These assets could be
liquidated and the proceeds delivered by dividend or loan to the Parent.
For the quarter ended March 31, 2007, the Parent's quarterly average
commercial paper borrowings were $133 million compared with $447 million in
2006. At March 31, 2007, the Parent had cash of $2,097 million, compared
with $685 million at March 31, 2006 and $908 million at December 31, 2006.
Net of commercial paper outstanding, the Parent's cash position at March
31, 2007 increased by $1,506 million compared with March 31, 2006. The
Parent has been increasing cash in anticipation of the repayment of long-
term debt that matures in the next twelve months.
On October 10, 2006, the Company entered into a new credit agreement
of $250 million with 11 financial institutions. The fee on this facility
depends on the Company's credit rating and is currently six basis points.
The credit agreement requires the Company to maintain: shareholders' equity
of $5 billion; a ratio of Tier 1 capital plus the allowance for credit
losses to nonperforming assets of at least 2.5; a double leverage ratio
less than 1.3; and adequate capitalization of all its banks for regulatory
purposes. This line of credit matures in October 2011. There were no
borrowings under this line of credit at March 31, 2007.
The Company also has the ability to access the capital markets.
Access to the capital markets is partially dependent on the Company's
credit ratings, which as of April 30, 2007 were as follows:
The Bank of
Parent Parent Parent Senior New York
Commercial Subordinated Long-Term Long-Term
Paper Long-Term Debt Debt Deposits Outlook
---------- -------------- ------------- ----------- -------
Standard &
Poor's A-1 A A+ AA- Stable
Moody's P-1 Aa3 Aa2 Aaa Stable
Fitch F1+ A+ AA- AA Positive
Dominion Bond
Rating Service R-1(middle) A(high) AA(low) AA Stable
Moody's upgraded the Company's senior debt ratings for the Bank from
Aa2 to Aaa in March 2007 and for the Parent from Aa3 to Aa2 in April 2007.
The Parent's major uses of funds are payment of dividends, principal
and interest on its borrowings, acquisitions, and additional investment in
its subsidiaries.
The Parent has $700 million of long-term debt that becomes due in 2007
subsequent to March 31, 2007 and $1,450 million of long-term debt that is
due in 2008. The Company has $250 million of subordinated debt that became
callable and steps up to a higher interest rate in 2007 and $400 million of
subordinated debt that became callable and steps up to a higher interest
rate in 2008. The Company expects that it will call this debt when the
interest rate steps up. In addition, the Parent periodically has the
option to call $339 million of subordinated debt in 2007, which it will
call and refinance if market conditions are favorable. The Parent expects
to refinance any debt it repays by issuing a combination of senior and
subordinated debt.
39
The Company has $800 million of preferred trust securities that are
callable in 2007. These securities qualify as Tier 1 Capital. All of the
Company's preferred trust securities are swapped to floating rate. The
Company has not yet decided if it will call these securities. The decision
to call will be based on interest rates, the availability of cash and
capital, and regulatory conditions. If the Company calls the preferred
trust securities, it expects to replace them with new preferred trust
securities or senior or subordinated debt. See discussion of qualification
of preferred trust securities as capital in "Capital Resources."
Double leverage is the ratio of investment in subsidiaries divided by
the Company's consolidated equity plus preferred trust securities. The
Company's double leverage ratio at March 31, 2007 and 2006 was 101.34% and
106.36%, respectively. The Company's target double leverage ratio is a
maximum of 120%. The double leverage ratio is monitored by regulators and
rating agencies and is an important constraint on the Company's ability to
invest in its subsidiaries to expand its businesses.
Pershing LLC, an indirect subsidiary of the Company, has committed and
uncommitted lines of credit in place for liquidity purposes. The committed
line of credit of $500 million with four financial institutions matures in
March 2008. Average daily borrowing under these lines was $4 million, in
aggregate, during the first quarter of 2007. Pershing LLC has three
separate uncommitted lines of credit amounting to $1 billion in aggregate.
Average daily borrowing under these lines was $9 million, in aggregate,
during the first quarter of 2007.
Pershing Limited, an indirect U.K.-based subsidiary of the Company,
has committed and uncommitted lines in place for liquidity purposes. The
committed lines of credit of $275 million with four financial institutions
matures in March 2008. There were no borrowings against this line of credit
during the first quarter of 2007. Pershing Limited has three separate
uncommitted lines of credit amounting to $300 million in aggregate. Average
daily borrowing under these lines was $107 million, in aggregate, during
the first quarter of 2007.
The following comments relate to the information disclosed in the
Consolidated Statements of Cash Flows.
Cash provided by operating activities was $2.0 billion for the first
three months of 2007, compared with $0.5 billion provided by operating
activities through March 31, 2006. The source of funds in 2007 was
principally due to trading activities and net income. The source of funds
in 2006 was principally due to the changes in accruals and other and net
income.
In the first three months of 2007, cash provided by investing
activities was $0.3 billion as compared to cash used for investing
activities in the first three months of 2006 of $1.0 billion. In the first
three months of 2007, changes in federal funds sold and securities
purchased under resale agreements and paydowns of securities available-for-
sale were a significant source of funds. Significant uses of funds in 2006
were purchases of securities available-for-sale and changes in federal
funds sold and securities purchased under resale agreements.
Through March 31, 2007, cash used for financing activities was $3.0
billion, compared to $0.4 billion provided by financing activities in the
first three months of 2006. In the first three months of 2007, deposits
were a significant use of funds. Primary sources of funds in 2006 included
deposits and net proceeds from the issuance of long-term debt.
40
CAPITAL RESOURCES
Shareholders' equity was $11,527 million at March 31, 2007, compared
with $10,101 million at March 31, 2006, and $11,593 million at December 31,
2006. During the first quarter of 2007, the Company retained $266 million
of earnings. Capital was also impacted by after-tax adjustments related to
FSP FAS 13-2 of $389 million and FIN 48 of $27 million. In April 2007, the
Company declared a quarterly common stock dividend of 22 cents per share.
In the first quarter of 2007, the Company issued $55 million of
callable medium-term subordinated notes bearing interest at rates from
5.60% to 5.85%. The notes are due in 2022 and 2032 and are callable by the
Company after three to five years. The notes qualify as Tier 2 capital.
In the first quarter of 2007, the Company also issued $750 million of
five-year senior holding company debt. The issuance consisted of $500
million at a floating rate of LIBOR plus 10 basis points and $250 million
at a fixed rate tranche at five-year treasuries plus 57 basis points.
Regulators establish certain levels of capital for bank holding
companies and banks, including the Company and the Bank, in accordance with
established quantitative measurements. For the Parent to maintain its
status as a financial holding company, the Bank must, among other things,
qualify as well capitalized. In addition, major bank holding companies such
as the Parent are expected by the regulators to be well capitalized. As of
March 31, 2007 and 2006, the Company and the Bank were considered well
capitalized on the basis of the ratios (defined by regulation) of Total and
Tier 1 capital to risk-weighted assets and leverage (Tier 1 capital to
average assets), which are shown as follows:
March 31, 2007 March 31, 2006 Well Adequately
------------------ ------------------ Company Capitalized Capitalized
Company Bank Company Bank Targets Guidelines Guidelines
--------- ------- --------- ------- ---------- ----------- -----------
Tier 1 (1) 8.43% 8.43% 8.28% 9.14% 8.00% 6% 4%
Total capital (2) 12.81 11.70 12.44 12.07 10 8
Leverage 6.80 6.95 6.51 7.26 5 3-5
Tangible common equity 5.31 5.92 5.52 6.67 5.00
Adjusted tangible
common equity (3) 5.47 6.11 5.54 6.70 N.A. N.A.
(1) Tier 1 capital consists, generally, of common equity, preferred trust securities (subject to
limitations in 2009), and certain qualifying preferred stock, less goodwill and most other
intangibles.
(2) Total Capital consists of Tier 1 capital plus Tier 2 capital. Tier 2 capital consists,
generally, of certain qualifying preferred stock and subordinated debt and a portion of the
loan loss allowance.
(3) Adjusted for deferred tax liabilities associated with non-tax deductible identifiable intangible
assets.
In a non-taxable business combination, such as the Company's planned
merger with Mellon, deferred tax liabilities are recorded in relation to
identifiable intangible assets. The recording of this deferred tax
liability results in an increase in goodwill equal to the amount of the
liability. Bank regulators and some rating agencies and analysts adjust
equity upward for the amount of this deferred tax liability since it is a
liability for accounting purposes and will never require a cash settlement.
As a result, the Company believes Tier 1 and adjusted TCE should be its
primary capital metrics.
The Tier 1 and adjusted TCE ratios vary depending on the size of the
balance sheet at quarter-end and the impact of interest rates on unrealized
gains and losses among other factors. The balance sheet size fluctuates
from quarter to quarter based on levels of customer and market activity. In
general, when servicing clients are more actively trading securities,
deposit balances and the balance sheet as a whole, are higher to finance
these activities. For quarter-ends in 2007, the size of the balance sheet
will depend on the novation of deposits and the receipt of approval to open
new subsidiaries related to the Acquired Corporate Trust Business and the
anticipated merger with Mellon.
41
The Company's Tier 1 capital and Total Capital ratios were 8.43% and
12.81% at March 31, 2007, compared with 8.28% and 12.44% at March 31, 2006,
and 8.19% and 12.49% at December 31, 2006. The leverage ratio was 6.80% at
March 31, 2007, compared with 6.51% at March 31, 2006, and 6.67% at
December 31, 2006. The Company's TCE as a percentage of total assets was
5.31% at March 31, 2007, compared with 5.52% at March 31, 2006, and 5.13%
at December 31, 2006. The Company's adjusted TCE as a percentage of total
assets was 5.47% at March 31, 2007, compared with 5.54% at March 31, 2006,
and 5.30% at December 31, 2006.
Certain accounting charges in the first quarter of 2007 reduced the
Company's Tier 1 and adjusted TCE ratios to 8.43% and 5.47%.
A billion dollar change in risk-weighted assets changes the Tier 1
ratio by 11 basis points while a $100 million change in common equity
changes the Tier 1 ratio by 13 basis points.
A billion dollar change in assets changes the adjusted TCE ratio by 6
basis points while a $100 million change in common equity changes the
adjusted TCE ratio by 11 basis points.
At March 31, 2007, the Company has $1,150 million of trust preferred
securities outstanding. On March 1, 2005, the Board of Governors of the
Federal Reserve System (the "FRB") adopted a final rule that allows the
continued limited inclusion of trust preferred securities in the Tier 1
capital of bank holding companies (BHCs). Under the final rule, the Company
will be subject to a 15 percent limit in the amount of trust preferred
securities that can be included in Tier 1 capital, net of goodwill, less
any related deferred tax liability. Amounts in excess of these limits will
continue to be included in Tier 2 capital. The final rule provides a five-
year transition period, ending March 31, 2009, for application of
quantitative limits. Under the transition rules and the final rules, the
Company expects all its trust preferred securities to continue to qualify
as Tier 1 capital. Both the Company and the Bank are expected to remain
"well capitalized" under the final rule.
The following table presents the components of the Company's risk-
based capital at March 31, 2007 and 2006:
March 31,
------------------
(In millions) 2007 2006
------- -------
Shareholders' equity $11,527 $10,101
Trust preferred securities 1,150 1,150
Adjustments: Goodwill and intangibles (6,421) (4,741)
Other 248 88
------- -------
Tier 1 capital 6,504 6,598
------- -------
Qualifying unrealized equity security gains 4 7
Qualifying subordinated debt 2,946 2,745
Qualifying allowance for loan losses 425 566
------- -------
Tier 2 capital 3,375 3,318
------- -------
Total risk-based capital $ 9,879 $ 9,916
======= =======
Total risk-adjusted assets $77,130 $79,697
======= =======
42
TRADING ACTIVITIES
The fair value and notional amounts of the Company's financial
instruments held for trading purposes at March 31, 2007 and 2006 are as
follows:
March 31, 2007 1Q07 Average
--------------------------- ------------------
(In millions) Notional Fair Value Fair Value
------------------ ------------------
Trading Account Amount Assets Liabilities Assets Liabilities
--------------- -------- ------ ----------- ------ -----------
Interest rate contracts:
Futures and forward
contracts $ 63,886 $ - $ - $ - $ -
Swaps 341,824 1,329 905 1,486 1,071
Written options 208,423 - 631 - 684
Purchased options 191,279 181 - 190 -
Foreign exchange contracts:
Swaps 2,457 - - - -
Written options 10,593 - 113 - 113
Purchased options 11,151 55 - 72 -
Commitments to purchase
and sell foreign exchange 125,099 297 267 410 390
Debt securities - 1,607 167 2,747 216
Credit derivatives 1,899 5 6 3 9
Equities 20,956 195 180 260 323
Commodities & other derivatives 268 6 1 4 1
------ ----------- ------ -----------
Total trading account $3,675 $ 2,270 $5,172 $ 2,807
====== =========== ====== ===========
March 31, 2006 1Q06 Average
--------------------------- ------------------
(In millions) Notional Fair Value Fair Value
------------------ ------------------
Trading Account Amount Assets Liabilities Assets Liabilities
--------------- -------- ------ ----------- ------ -----------
Interest rate contracts:
Futures and forward
contracts $ 98,606 $ 32 $ - $ 9 $ -
Swaps 261,730 1,416 826 1,886 1,174
Written options 220,001 - 1,045 - 1,090
Purchased options 182,731 190 - 174 -
Foreign exchange contracts:
Swaps 2,404 - - - -
Written options 6,070 - 114 - 54
Purchased options 7,913 125 - 100 -
Commitments to purchase
and sell foreign exchange 81,308 125 123 93 140
Debt securities - 5,143 176 4,715 234
Credit derivatives 1,491 1 6 1 7
Equities 5,383 97 68 135 118
------ ----------- ------ -----------
Total trading account $7,129 $ 2,358 $7,113 $ 2,817
====== =========== ====== ===========
The Company's trading activities are focused on acting as a market
maker for the Company's customers. The risk from these market making
activities and from the Company's own positions is managed by the Company's
traders and limited in total exposure as described below.
The Company manages trading risk through a system of position limits,
a value at risk (VAR) methodology-based on a Monte Carlo simulation, stop
loss advisory triggers, and other market sensitivity measures. Risk is
monitored and reported to senior management by a separate unit on a daily
basis. Based on certain assumptions, the VAR methodology is designed to
capture the potential overnight pre-tax dollar loss from adverse changes in
fair values of all trading positions. The calculation assumes a one-day
holding period for most instruments, utilizes a 99% confidence level, and
incorporates the non-linear characteristics of options. The VAR model is
used to calculate economic
43
capital, which is allocated to the business units for computing risk-adjusted
performance.
As VAR methodology does not evaluate risk attributable to
extraordinary financial, economic or other occurrences, the risk assessment
process includes a number of stress scenarios based upon the risk factors
in the portfolio and management's assessment of market conditions.
Additional stress scenarios based upon historic market events are also
tested. Stress tests by their design incorporate the impact of reduced
liquidity and the breakdown of observed correlations. The results of these
stress tests are reviewed weekly with senior management.
The following table indicates the calculated VAR amounts for the
trading portfolio for the periods indicated.
(In millions) 1st Quarter 2007
Market Risk -------------------------------------
----------- Average Minimum Maximum 3/31/07
------- ------- ------- -------
Interest rate $ 3.2 $ 1.9 $ 4.9 $ 4.5
Foreign exchange 1.2 0.6 2.1 1.6
Equity 2.0 0.8 6.6 1.8
Credit derivatives 0.9 0.6 1.4 1.3
Commodities 1.7 - 3.3 3.3
Diversification (2.0) NM NM (3.4)
Overall portfolio 7.0 3.0 10.9 9.1
(In millions) 1st Quarter 2006
Market Risk -------------------------------------
----------- Average Minimum Maximum 3/31/06
------- ------- ------- -------
Interest rate $ 2.8 $ 2.0 $ 4.4 $ 2.9
Foreign exchange 1.0 0.6 1.7 0.8
Equity 0.8 0.5 1.2 0.9
Credit derivatives 0.9 0.6 1.2 0.9
Diversification (1.4) NM NM (1.4)
Overall portfolio 4.1 3.3 5.4 4.1
NM - Because the minimum and maximum may occur on different days for different
risk components, it is not meaningful to compute a portfolio
diversification effect.
During the first quarter of 2007, interest rate risk generated
approximately 31% of average VAR, credit derivatives risk generated 13% of
average VAR, foreign exchange risk accounted for 12% of average VAR,
commodities risk generated 25% of average VAR, and equity risk generated
19% of average VAR. The commodities VAR reflects the option contract the
Company uses to hedge its Section 29 synthetic fuel tax credits. During
the first quarter of 2007, the Company's daily trading loss did not exceed
the Company's calculated VAR amounts on any given day.
The following table of total daily revenue or loss captures trading
volatility and shows the number of days in which the Company's trading
revenues fell within particular ranges during the past year:
Distribution of Revenues(1)
--------------------------
For the Quarter Ended
--------------------------------------------------
(Dollars in millions) 3/31/07 12/31/06 9/30/06 6/30/06 3/31/06
--------------------------------------------------
Revenue Range Number of Occurrences
---------------------- --------- --------- --------- ---------- ---------
Less than $(2.5) 0 0 0 0 0
$(2.5)~ $ 0 6 4 3 2 4
$ 0 ~ $ 2.5 33 45 52 39 40
$ 2.5 ~ $ 5.0 20 11 8 21 18
More than $5.0 3 2 0 2 0
(1) Based on revenues before deducting share of joint venture partner,
Susquehanna Trading.
44
ASSET/LIABILITY MANAGEMENT
The Company's asset/liability management activities include lending,
investing in securities, accepting deposits, raising money as needed to
fund assets, and processing securities and other transactions. The market
risks that arise from these activities are interest rate risk, and to a
lesser degree, foreign exchange risk. The Company's primary market risk is
exposure to movements in U.S. dollar interest rates. Exposure to movements
in foreign currency interest rates also exists, but to a significantly
lower degree. The Company actively manages interest rate sensitivity. In
addition to gap analysis, the Company uses earnings simulation and
discounted cash flow models to identify interest rate exposures.
An earnings simulation model is the primary tool used to assess
changes in pre-tax net interest income. The model incorporates
management's assumptions regarding interest rates, balance changes on core
deposits, and changes in the prepayment behavior of loans and securities,
and the impact of derivative financial instruments used for interest rate
risk management purposes. These assumptions have been developed through a
combination of historical analysis and future expected pricing behavior.
These assumptions are inherently uncertain, and, as a result, the earnings
simulation model cannot precisely estimate net interest income or the
impact of higher or lower interest rates on net interest income. Actual
results may differ from projected results due to timing, magnitude and
frequency of interest rate changes and changes in market conditions and
management's strategies, among other factors.
The Company evaluates the effect on earnings by running various
interest rate ramp scenarios up and down from a baseline scenario, which
assumes no changes in interest rates. These scenarios are reviewed to
examine the impact of large interest rate movements. Interest rate
sensitivity is quantified by calculating the change in pre-tax net interest
income between the scenarios over a 12-month measurement period. The
measurement of interest rate sensitivity is the percentage change in net
interest income as shown in the following table:
(Dollars in millions) Estimated Changes in Net Interest Income
Pro Forma
----------------------------------------
March 31, 2007 December 31, 2006
$ % $ %
--------- -------- ---------- ------
+200 Basis Point Ramp vs. Stable Rate $ 15 0.8% $ 4 0.2%
+100 Basis Point Ramp vs. Stable Rate 18 1.0 17 0.9
-100 Basis Point Ramp vs. Stable Rate (13) (0.7) (13) (0.7)
-200 Basis Point Ramp vs. Stable Rate (25) (1.4) (35) (1.9)
The pro forma data in the above table reflects the swap with JPMorgan
Chase as if the transaction was fully integrated into the Company on March
31, 2007 and December 31, 2006. The Company's swap with JPMorgan Chase would
have resulted in a more liability-sensitive balance sheet because corporate
trust liabilities reprice more quickly than retail deposits. However, among
other actions, the Company restructured its investment portfolio to readjust
its interest rate sensitivity.
The baseline scenario's Fed Funds rate in the March 31, 2007 analysis
and the December 31, 2006 analysis was 5.25%. The 100 basis point ramp
scenarios assumes short-term rates change 25 basis points in each of the
next four quarters, while the 200 basis point ramp scenarios assumes a 50
basis point per quarter change. Both the +100 basis point and the +200
basis point March 31, 2007 scenarios assume a steepening of the yield curve
with 10-year rates rising 184 and 284 basis points respectively. These
scenarios do not reflect strategies that management could employ to limit
the impact as interest rate expectations change.
The above table relies on certain critical assumptions including
depositors' behavior related to interest rate fluctuations and the
prepayment and extension risk in certain of the Company's assets. To the
extent that actual behavior is different from that assumed in the models,
there could be a change in interest rate sensitivity.
45
STATISTICAL INFORMATION
THE BANK OF NEW YORK COMPANY, INC.
Average Balances and Rates on a Taxable Equivalent Basis
(Dollars in millions)
For the three months For the three months
ended March 31, 2007 ended March 31, 2006(1)
---------------------------- ----------------------------
Average Average Average Average
Balance Interest Rate Balance Interest Rate
-------- -------- ------- -------- -------- -------
ASSETS
------
Interest-bearing
deposits in banks
(primarily foreign) $ 13,546 $ 146 4.36% $ 9,624 $ 86 3.61%
Federal funds sold and securities
purchased under resale agreements 4,435 57 5.23 1,691 15 3.64
Margin loans 5,401 84 6.33 5,655 77 5.54
Non-margin loans
Domestic offices 19,231 244 5.11 16,321 184 4.54
Foreign offices 11,321 163 5.85 9,815 126 5.21
--------- -------- --------- --------
Total non-margin loans 30,552 407 5.38 26,136 310 4.79
--------- -------- --------- --------
Securities
U.S. government obligations 86 1 4.95 225 2 4.22
U.S. government agency obligations 2,905 37 5.07 3,953 44 4.45
Obligations of states and
political subdivisions 86 2 8.22 118 3 8.04
Other securities 19,311 255 5.30 18,919 232 4.89
Trading securities 2,753 34 4.99 4,714 51 4.42
--------- -------- --------- --------
Total securities 25,141 329 5.25 27,929 332 4.76
--------- -------- --------- --------
Total interest-earning assets 79,075 1,023 5.22 71,035 820 4.65
-------- --------
Allowance for credit losses (286) (333)
Cash and due from banks 2,424 4,269
Other assets 20,762 16,860
Assets of discontinued operations
held for sale 66 - 14,302 185 5.24
--------- -------- --------- --------
TOTAL ASSETS $ 102,041 $ 1,023 $ 106,133 $ 1,005
========= ======== ========= ========
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
Interest-bearing deposits
Money market rate accounts $ 6,169 $ 45 2.98% $ 5,426 $ 31 2.29%
Savings 416 2 1.85 468 1 1.13
Certificates of deposit of
$100,000 & over 3,133 42 5.43 4,246 48 4.59
Other time deposits 584 7 5.18 903 10 4.41
Foreign offices 33,560 304 3.67 30,220 208 2.80
--------- -------- --------- --------
Total interest-bearing deposits 43,862 400 3.70 41,263 298 2.93
Federal funds purchased and
securities sold under repurchase
agreements 1,527 19 4.97 1,966 20 4.19
Other borrowed funds 1,870 13 2.88 1,980 20 4.02
Payables to customers and broker-dealers 4,747 42 3.59 5,231 40 3.10
Long-term debt 8,888 120 5.42 8,011 96 4.81
--------- -------- --------- --------
Total interest-bearing liabilities 60,894 594 3.95 58,451 474 3.28
-------- --------
Noninterest-bearing deposits 14,903 10,119
Other liabilities 14,901 13,373
Common shareholders' equity 11,277 9,888
Liabilities of discontinued operations
held for sale 66 - 14,302 36 1.02
--------- -------- --------- --------
TOTAL LIABILITIES AND
SHAREHOLDERS' EQUITY $ 102,041 $ 594 $ 106,133 $ 510
========= ======== ========= =======
Interest earnings,
continuing operations $ 429 $ 346
======== =======
Net interest margin 2.18% 1.95%
======= =======
Note:
(1) Average balances and rates have been impacted by allocations made to match assets of
discontinued operations held for sale with liabilities of discontinued operations held for
sale.
46
SUPPLEMENTAL INFORMATION
On October 1, 2006, the Company acquired JPMorgan Chase's corporate trust
business and sold to JPMorgan Chase the Company's Retail Business. The
transaction further increased the Company's focus on the securities services
and asset management businesses that are at the core of its long-term business
strategy.
For the quarters ended March 31, 2007 and March 31, 2006, the Company has
prepared supplemental financial information as follows:
* Full income statement for the Retail Business, which is reflected as
discontinued operations
* Adjusted results, which combine continuing and discontinued operations
to provide continuity with historical results
* Continuing operations and adjusted results including and excluding
merger and integration costs
The Company believes that providing supplemental adjusted non-GAAP
financial information is useful to investors in understanding the underlying
operating performance of the Company and its businesses and performance
trends, particularly in view of the materiality and strategic significance of
the JPMorgan Chase transaction. By combining the results of continuing and
discontinued operations and excluding merger and integration costs, the
Company believes investors can gain greater insight into the operating
performance of the Company in relation to historic results. Although the
Company believes that the non-GAAP financial measures presented in this report
enhance investors' understanding of the Company's business and performance,
these non-GAAP measures should not be considered an alternative to GAAP.
47
THE BANK OF NEW YORK COMPANY, INC.
SUPPLEMENTAL INFORMATION
------------------------
Consolidated Statements of Income
(Dollars in millions, except per share amounts)
(Unaudited)
Quarter Ended March 31, 2007 Quarter Ended March 31, 2006
---------------------------------------- -----------------------------------------
Continuing Discontinued Adjusted Continuing Discontinued Adjusted
Operations Operations Results (1) Operations Operations Results (1)
---------- ------------- ---------- ---------- ------------ -----------
Noninterest income
------------------
Securities servicing fees
Asset servicing $ 393 $ - $ 393 $ 335 $ - $ 335
Issuer services 319 - 319 154 - 154
Clearing services 278 - 278 342 - 342
------ ------ ------ ------ ------ ------
Total securities
servicing fees 990 - 990 831 - 831
Global payment services 50 - 50 51 8 59
Asset and wealth
management fees 153 - 153 127 11 138
Performance fees 14 - 14 7 - 7
Financing-related fees 52 - 52 63 37 100
Foreign exchange and other
trading activities 128 - 128 113 2 115
Securities gains/(losses) 2 - 2 (4) - (4)
Asset/investment income 35 - 35 34 - 34
Other 51 14 65 43 13 56
------ ------ ------ ------ ------ ------
Total noninterest income 1,475 14 1,489 1,265 71 1,336
------ ------ ------ ------ ------ ------
Net interest income
------------------- 427 - 427 339 149 488
Provision for credit losses (15) - (15) - 5 5
------ ------ ------ ------ ------ ------
Net interest income after
provision for
credit losses 442 - 442 339 144 483
------ ------ ------ ------ ------ ------
Noninterest expense
-------------------
Staff 720 9 729 604 64 668
Net occupancy 79 - 79 68 20 88
Furniture and equipment 50 - 50 51 2 53
Clearing 37 - 37 50 - 50
Sub-custodian expenses 34 - 34 34 - 34
Software 54 - 54 55 1 56
Business development 30 - 30 23 9 32
Communications 19 - 19 26 1 27
Professional, legal, and other
purchased services 130 2 132 82 8 90
Distribution and servicing 4 - 4 4 - 4
Amortization of intangibles 28 - 28 13 - 13
Merger and integration costs 15 8 23 - - -
Other 72 - 72 59 8 67
------ ------ ------ ------ ------ ------
Total noninterest expense 1,272 19 1,291 1,069 113 1,182
------ ------ ------ ------ ------ ------
Income before income taxes 645 (5) 640 535 102 637
Income taxes 208 (2) 206 175 40 215
------ ------ ------ ------ ------ ------
Net income 437 (3) 434 360 62 422
Merger and integration cost,
net of taxes 10 5 15 - - -
------ ------ ------ ------ ------ ------
Net income excluding merger
and integration costs $ 447 $ 2 $ 449 $ 360 $ 62 $ 422
====== ====== ====== ====== ====== ======
Diluted earnings per share $ 0.57 $ - $ 0.57 $ 0.47 $ 0.08 $ 0.55
Diluted earnings per share
excluding merger and
integration costs 0.59 - 0.59 0.47 0.08 0.55
Note:
(1) Adjusted results combine continuing and discontinued operations to provide continuity with historical
results.
48
MERGER AGREEMENT WITH MELLON FINANCIAL CORPORATION ("MELLON")
On December 3, 2006, the Company and Mellon entered into an Agreement
and Plan of Merger (the "Merger Agreement"), pursuant to which the Company
and Mellon will each merge with and into a newly formed corporation to be
called The Bank of New York Mellon Corporation. The boards of directors
of both companies have unanimously approved the Merger Agreement. The
parties amended and restated the Merger Agreement on February 23, 2007 and
again on March 30, 2007. The board of directors of each company has
adopted a resolution recommending the adoption of the Merger Agreement by
its respective shareholders, and each party has agreed to put these
matters before their respective shareholders for consideration. Subject
to the customary closing conditions, the merger is expected to close early
in the third quarter of 2007. The Company and Mellon filed a joint proxy
statement/prospectus with the Securities and Exchange Commission ("SEC")
regarding the proposed merger in late February and filed amendments to the
joint proxy statement/prospectus with the SEC in April. The joint proxy
statement/prospectus became effective on April 17, 2007. The Company and
Mellon will each hold separate special shareholder meetings on May 24,
2007 to approve the merger for shareholders of record as of April 12,
2007.
FORWARD-LOOKING STATEMENTS AND RISK FACTORS
Some statements in this document are forward-looking. These include
all statements about the future results of the Company, projected business
growth, statements with respect to the proposed merger with Mellon,
expectations with respect to operations after the merger, the expected
outcome of legal, regulatory and investigatory proceedings, predicted loan
losses, and the Company's plans, objectives and strategies. In this
report, any press release or any oral statement that the Company or its
executives may make, words such as "estimate," "forecast," "project,"
"anticipate," "confident," "target," "expect," "intend," "think,"
"continue," "seek," "believe," "plan," "goal," "could," "should," "may,"
"will," "strategy," "highly attractive," "rapidly evolving financial
markets," "synergies," "opportunities," "superior returns," "well-
positioned," "trends," "pro forma" and words of similar meaning, signify
forward-looking statements.
In addition, with respect to the Mellon transaction, actual results
may differ materially from the anticipated results or other expectations
expressed in the forward-looking statements as a result of risks and
uncertainties, including but not limited to, the businesses of the Company
and Mellon may not be integrated successfully or the integration may be
more difficult, time-consuming or costly than expected; the combined
company may not realize, to the extent or at the time the Company expects,
revenue synergies and cost savings from the transaction; revenues
following the transaction may be lower than expected as a result of losses
of customers or other reasons; deposit attrition, operating costs,
customer loss and business disruption following the transaction,
including, without limitation, difficulties in maintaining relationships
with employees, may be greater than expected; governmental approvals of
the transaction may not be obtained on the proposed terms or expected
timeframe; a weakening of the economies in which the combined company will
conduct operations may adversely affect the Company's operating results;
the Company's and Mellon's shareholders may fail to approve the
transaction; the U.S. and foreign legal and regulatory framework could
adversely affect the operating results of the combined company; and
fluctuations in interests rates, currency exchange rates and securities
prices may adversely affect the operating results of the combined company.
Additional factors that could cause the Company's and Mellon's results to
differ materially from those described in the forward-looking statements
can be found in The Bank of New York Company, Inc.'s and Mellon Financial
Corporation's Annual Report on Form 10-K for the year ended December 31,
2006 and any subsequent reports filed with the SEC pursuant to the
Securities Exchange Act of 1934, as amended, as well as other
uncertainties affecting future results and the value of the Company's
stock.
Forward-looking statements, including the Company's discussions and
projections of future results of operations and discussions of future
plans contained in the MD&A and elsewhere in this Form 10-Q, are based on
49
management's current expectations and assumptions that involve risks and
uncertainties and that are subject to change based on various important
factors (some of which are beyond the Corporation's control), including
adverse changes in market conditions and the timing of such changes, and
the actions that management could take in response to these changes.
Actual results may differ materially from those expressed or implied as a
result of these risks and uncertainties. The "Risk Factors" discussed in
the section "Forward-Looking Statements and Risk Factors" in Part I, Item
1A of the Company's Annual Report on Form 10-K for the year ended December
31, 2006 could cause or contribute to such differences. Investors should
consider all risks mentioned elsewhere in this document and in subsequent
reports filed by the Company with the SEC pursuant to the Securities and
Exchange Act of 1934, as amended, as well as other uncertainties affecting
future results and the value of the Company's stock.
All forward-looking statements speak only as of the date on which
such statements are made, and the Company undertakes no obligation to
update any statement to reflect events or circumstances after the date on
which such forward-looking statement is made or to reflect the occurrence
of unanticipated events.
MELLON TRANSACTION
The proposed transaction between The Bank of New York Company, Inc.
and Mellon Financial Corporation will be submitted to The Bank of New York
Company, Inc.'s and Mellon Financial Corporation's shareholders for their
consideration. In connection with the proposed transaction, The Bank of
New York Mellon Corporation, an entity formed by The Bank of New York
Company, Inc. and Mellon Financial Corporation for purposes of
facilitating the proposed transaction, has filed a registration statement
on Form S-4 (Registration No. 333-140863) containing a definitive joint
proxy statement/prospectus that has been mailed to the shareholders of
each of The Bank of New York Company, Inc. and Mellon Financial
Corporation. Shareholders are urged to read the registration statement and
the joint proxy statement/prospectus regarding the proposed transaction
and any other relevant documents filed with the Securities and Exchange
Commission, as well as any amendments or supplements to those documents,
because they will contain important information. Shareholders may obtain a
free copy of the joint proxy statement/prospectus, as well as other
filings containing information about The Bank of New York Company, Inc.,
Mellon Financial Corporation and The Bank of New York Mellon Corporation,
without charge, at the SEC's Internet site (http://www.sec.gov). Copies of
the joint proxy statement/prospectus and other SEC filings that are
incorporated by reference in the joint proxy statement/prospectus are also
available, without charge, from The Bank of New York Company, Inc.,
Investor Relations, One Wall Street, 31st Floor, New York, New York 10286
(212-635-1578), or from Mellon Financial Corporation, Secretary of Mellon
Financial Corporation, One Mellon Center, Pittsburgh, Pennsylvania 15258-
0001 (800-205-7699).
Directors and executive officers of The Bank of New York Company,
Inc. and Mellon Financial Corporation and other persons may be deemed to
be participants in the solicitation of proxies from the shareholders of
The Bank of New York Company Inc. and/or Mellon Financial Corporation, in
respect of the proposed transaction. Information about the directors and
executive officers of The Bank of New York Company, Inc. is set forth in
the proxy statement for The Bank of New York Company, Inc.'s annual
meeting of shareholders, as filed with the SEC on March 14, 2007.
Information about the directors and executive officers of Mellon Financial
Corporation is set forth in the proxy statement for Mellon Financial
Corporation's 2007 annual meeting of shareholders, as filed with the SEC
on March 19, 2007. Additional information regarding the participants in
the proxy solicitation and a description of their direct and indirect
interests, by security holdings or otherwise, is contained in the
definitive joint proxy statement/prospectus.
50
GOVERNMENT MONETARY POLICIES AND COMPETITION
Government Monetary Policies
----------------------------
The Federal Reserve Board has the primary responsibility for United
States monetary policy. Its actions have an important influence on the
demand for credit and investments and the level of interest rates, and thus
on the earnings of the Company.
Competition
-----------
The businesses in which the Company operates are very competitive.
Competition is provided by both unregulated and regulated financial
services organizations, whose products and services span the local,
national, and global markets in which the Company conducts operations.
A wide variety of domestic and foreign companies compete for
processing services. For securities servicing and global payment services,
international, national, and regional commercial banks, trust banks,
investment banks, specialized processing companies, outsourcing companies,
data processing companies, stock exchanges, and other business firms offer
active competition. In the asset management and wealth management markets,
international, national, and regional commercial banks, standalone asset
management companies, mutual funds, securities brokerage firms, insurance
companies, investment counseling firms, and other business firms and
individuals actively compete for business. Commercial banks, savings banks,
savings and loan associations, and credit unions actively compete for
deposits, and money market funds and brokerage houses offer deposit-like
services. These institutions, as well as commercial finance companies,
factors, insurance companies and pension trusts, are important competitors
for various types of loans. Issuers of commercial paper compete actively
for funds and reduce demand for bank loans.
WEBSITE INFORMATION
The Company makes available on its website: www.bankofny.com
* All of its SEC filings, including annual report on Form 10-K,
quarterly reports on Form 10-Q, current reports on Form 8-K
and all amendments to these reports, SEC Forms 3, 4 and 5 and
its proxy statement as soon as reasonably practicable after
such material is electronically filed with or furnished to the
SEC,
* Its earnings releases and management conference calls and
presentations, and
* Its corporate governance guidelines and the charters of the
Audit and Examining, Compensation and Organization, and
Nominating and Governance Committees of its Board of
Directors.
The corporate governance guidelines and committee charters are
available in print to any shareholder who requests them. Requests should be
sent to The Bank of New York Company, Inc., Corporate Communications, One
Wall Street, NY, NY 10286.
51
THE BANK OF NEW YORK COMPANY, INC.
Consolidated Balance Sheets
(Dollars in millions, except per share amounts)
(Unaudited)
March 31, December 31,
2007 2006
----------- -----------
Assets
------
Cash and due from banks $ 2,159 $ 2,840
Interest-bearing deposits with banks 13,474 13,172
Federal funds sold and securities purchased
under resale agreements 1,712 5,114
Securities
Held-to-maturity (fair value of
$1,557 at 03/31/07 and $1,710 at 12/31/06) 1,572 1,729
Available-for-sale 22,124 19,377
----------- -----------
Total securities 23,696 21,106
Trading assets at fair value 3,675 5,544
Loans 38,289 37,793
Reserve for loan losses (290) (287)
----------- -----------
Net loans 37,999 37,506
Premises and equipment 1,064 1,050
Accrued interest receivable 409 422
Goodwill 5,131 5,172
Intangible assets 1,447 1,453
Other assets 9,061 9,973
Assets of discontinued operations held for sale 21 18
----------- -----------
Total assets $ 99,848 $ 103,370
=========== ===========
Liabilities
-----------
Deposits
Noninterest-bearing (principally domestic offices) $ 17,269 $ 19,554
Interest-bearing deposits in domestic offices 9,312 10,041
Interest-bearing deposits in foreign offices 32,435 32,551
----------- -----------
Total deposits 59,016 62,146
Federal funds purchased and securities
sold under repurchase agreements 773 790
Trading liabilities 2,270 2,507
Payables to customers and broker-dealers 6,739 7,266
Other borrowed funds 1,714 1,625
Accrued taxes and other expenses 4,153 5,129
Other liabilities (including allowance for
lending-related commitments of
$135 at 03/31/07 and $150 at 12/31/06) 4,007 3,477
Long-term debt 9,585 8,773
Liabilities of discontinued operations held for sale 64 64
----------- -----------
Total liabilities 88,321 91,777
----------- -----------
Shareholders' Equity
--------------------
Common stock-par value $7.50 per share,
authorized 2,400,000,000 shares, issued
1,054,488,125 shares at 03/31/07 and
1,053,752,916 shares at 12/31/06 7,909 7,903
Additional capital 2,203 2,142
Retained earnings 9,294 9,444
Accumulated other comprehensive income (337) (317)
---------- -----------
19,069 19,172
Less: Treasury stock (296,062,120 shares at 03/31/07 and
297,790,159 shares at 12/31/06), at cost 7,539 7,576
Loan to ESOP (101,753 shares at 03/31/07
and 12/31/06), at cost 3 3
----------- -----------
Total shareholders' equity 11,527 11,593
----------- -----------
Total liabilities and shareholders' equity $ 99,848 $ 103,370
=========== ===========
Notes:(1) See accompanying Notes to Consolidated Financial Statements.
(2) The balance sheet at December 31, 2006 has been derived from the audited
financial statements at that date.
52
THE BANK OF NEW YORK COMPANY, INC.
Consolidated Statements of Income
(In millions, except per share amounts)
(Unaudited)
Quarter Ended
----------------------------
March 31, Dec 31, March 31,
2007 2006 2006
--------- ------- --------
Noninterest Income
------------------
Securities servicing fees
Asset servicing $ 393 $ 355 $ 335
Issuer services 319 340 154
Clearing services 278 263 342
------ ------ ------
Total securities servicing fees 990 958 831
Global payment services 50 51 51
Asset and wealth management fees 153 154 127
Performance fees 14 18 7
Financing-related fees 52 61 63
Foreign exchange and other trading activities 128 98 113
Securities gains/(losses) 2 2 (4)
Asset/investment income 35 47 34
Other 51 52 43
------ ------ ------
Total noninterest income 1,475 1,441 1,265
------ ------ ------
Net Interest Income
-------------------
Interest income 1,021 1,057 813
Interest expense 594 606 474
------ ------ ------
Net interest income 427 451 339
Provision for credit losses (15) (15) -
------ ------ ------
Net interest income after provision
for credit losses 442 466 339
------ ------ ------
Noninterest Expense
-------------------
Staff 720 736 604
Net occupancy 79 73 68
Furniture and equipment 50 45 51
Clearing 37 38 50
Sub-custodian expenses 34 33 34
Software 54 59 55
Business development 30 30 23
Communications 19 23 26
Professional, legal, and other purchased services 130 125 82
Distribution and servicing 4 5 4
Amortization of intangible assets 28 34 13
Merger and integration costs 15 17 -
Other 72 67 59
------ ------ ------
Total noninterest expense 1,272 1,285 1,069
------ ------ ------
Income
------
Income from continuing operations before income taxes 645 622 535
Provision for income taxes 208 195 175
------ ------ ------
Income from continuing operations 437 427 360
------ ------ ------
Discontinued operations
Income (loss) from discontinued operations (5) 2,130 102
Provision for income taxes (2) 768 40
------ ------ ------
Income (loss) from discontinued operations, net (3) 1,362 62
------ ------ ------
Net income $ 434 $1,789 $ 422
====== ====== ======
Earnings per Share
------------------
Basic
Income from continuing operations $ 0.58 $ 0.57 $ 0.47
Income from discontinued operations, net - 1.82 0.08
Net income 0.58 2.39 0.55
Diluted
Income from continuing operations $ 0.57 $ 0.56 $ 0.47
Income from discontinued operations, net - 1.80 0.08
Net income 0.57 2.36 0.55
Average Shares Outstanding (in thousands)
-----------------------------------------
Basic 750,737 746,688 763,851
Diluted 763,083 757,981 773,630
Note: (1) See accompanying Notes to Consolidated Financial Statements.
(2) Certain prior periods' amounts have been reclassified to conform to current period
presentation.
53
THE BANK OF NEW YORK COMPANY, INC.
Consolidated Statement of Changes in Shareholders' Equity
For the three months ended March 31, 2007
(Dollars in millions)
(Unaudited)
Common stock
Balance, January 1 $ 7,903
Issuances in connection with employee benefit plans 6
-------------
Balance, March 31 7,909
-------------
Additional capital
Balance, January 1 2,142
Issuances in connection with employee benefit plans 61
-------------
Balance, March 31 2,203
-------------
Retained earnings
Balance, January 1 9,444
Adjustments for the cumulative effect of applying FSP FAS 13-2 and
FIN 48, net of taxes of $(214) (416)
-------------
Balance, January 1 restated 9,028
Net income $ 434 434
Cash dividends on common stock (168)
-------------
Balance, March 31 9,294
-------------
Accumulated other comprehensive income
Balance, January 1 (317)
Net unrealized derivative gain/(loss) on cash flow hedges,
net of taxes of $13 (19) (19)
Foreign currency translation adjustment,
net of taxes of $- 1 1
Other adjustments, net of taxes of $- (2) (2)
-------------
Balance, March 31 (337)
----------- -------------
Total comprehensive income $ 414
===========
Less treasury stock
Balance, January 1 7,576
Issued (53)
Acquired 16
-------------
Balance, March 31 7,539
-------------
Less loan to ESOP
Balance, January 1 3
Loan to ESOP -
-------------
Balance, March 31 3
-------------
Total shareholders' equity, March 31, 2007 $ 11,527
=============
-------------------------------------------------------------------------------------------
Comprehensive income for the three months ended March 31, 2007 and 2006 was $414 and $367.
See accompanying Notes to Consolidated Financial Statements.
54
THE BANK OF NEW YORK COMPANY, INC.
Consolidated Statements of Cash Flows
(Dollars in millions)
(Unaudited)
For the three months
ended March 31,
2007 2006
-------- --------
Operating activities
Net income $ 434 $ 422
Adjustments to determine net cash attributable to
operating activities:
Provision for credit losses (15) 5
Depreciation and amortization 127 117
Deferred income taxes 62 (37)
Securities gains and venture capital income (18) (17)
Change in trading activities 1,608 (1,074)
Change in accruals and other, net (151) 1,117
-------- --------
Net cash provided by operating activities 2,047 533
-------- --------
Investing activities
Change in interest-bearing deposits in banks (219) 1,100
Change in margin loans 34 777
Purchases of securities held-to-maturity - (303)
Paydowns of securities held-to-maturity 35 65
Maturities of securities held-to-maturity 129 40
Purchases of securities available-for-sale (4,887) (3,260)
Sales of securities available-for-sale 60 890
Paydowns of securities available-for-sale 1,071 1,193
Maturities of securities available-for-sale 945 1,436
Net principal disbursed on loans to customers (1,055) (138)
Proceeds from loans held for sale and other loan sales - 33
Change in federal funds sold and securities
purchased under resale agreements 3,402 (2,356)
Purchases of premises and equipment/capitalized software (57) (41)
Acquisitions, net of cash disbursed (58) (339)
Proceeds from the sale of premises and equipment - -
Other, net 858 (57)
-------- --------
Net cash provided by/(used for)investing activities 258 (960)
-------- --------
Financing activities
Change in deposits (3,286) 637
Change in federal funds purchased and securities
sold under repurchase agreements (17) 69
Change in payables to customers and broker-dealers (526) (1,067)
Change in other borrowed funds 74 302
Net proceeds from the issuance of long-term debt 803 600
Repayments of long-term debt (11) (12)
Issuance of common stock 120 104
Tax benefit realized on share-based payment awards 15 9
Treasury stock acquired (16) (82)
Cash dividends paid (168) (164)
-------- --------
Net cash (used for)/provided by financing activities (3,012) 396
-------- --------
Effect of exchange rate changes on cash 26 (76)
-------- --------
Change in cash and due from banks (681) (107)
Cash and due from banks at beginning of period 2,840 3,515
Cash related to discontinued operations - (544)
-------- --------
Cash and due from banks at end of period $ 2,159 $ 2,864
======== ========
-------------------------------------------------------------------------------
Supplemental disclosures
Interest paid $ 626 $ 510
Income taxes paid 643 328
Income taxes refunded 1 2
-------------------------------------------------------------------------------
See accompanying Notes to Consolidated Financial Statements.
55
THE BANK OF NEW YORK COMPANY, INC.
Notes to Consolidated Financial Statements
1. General
-------
The accounting and reporting policies of The Bank of New York Company,
Inc., a financial holding company, and its consolidated subsidiaries (the
"Company") conform with U.S. generally accepted accounting principles and
general practice within the banking industry. Such policies are consistent
with those applied in the preparation of the Company's annual financial
statements.
The Company provides a complete range of banking and other financial
services to corporations and individuals worldwide through its business
segments: Asset and Wealth Management, Institutional Services, and Other.
"Business Segment Accounting Principles" and "Segment Financial Data" are
incorporated from the Business Segment Review section of Management's
Discussion and Analysis of the Company's Financial Condition and Results of
Operations ("MD&A"). There were no major customers from whom revenues were
individually material to the Company's performance.
The accompanying consolidated financial statements are unaudited. In
the opinion of management, all adjustments necessary for a fair
presentation of financial position, results of operations and cash flows
for the interim periods have been made. Certain other reclassifications
have been made to prior periods to place them on a basis comparable with
current period presentation.
2. Accounting Changes and New Accounting Pronouncements
----------------------------------------------------
The Company adopted Statement of Financial Accounting Standards
("SFAS") No. 123 ("SFAS 123"), "Accounting for Stock-Based Compensation,"
in 1995. At that time, as permitted by the standard, the Company elected
to continue to apply the provisions of Accounting Principles Board Opinion
No. 25 ("APB 25"), "Accounting for Stock Issued to Employees," and
accounted for the options granted to employees using the intrinsic value
method, under which no expense is recognized for stock options because they
were granted at the stock price on the grant date and therefore have no
intrinsic value.
On January 1, 2003, the Company adopted the fair value method of
accounting for its options under SFAS 123 as amended by SFAS No. 148 ("SFAS
148"), "Accounting for Stock-Based Compensation-Transition and Disclosure."
SFAS 148 permitted three different methods of adopting fair value: (1) the
prospective method, (2) the modified prospective method, and (3) the
retroactive restatement method. Under the prospective method, options
issued after January 1, 2003 are expensed while all options granted prior
to January 1, 2003 are accounted for under APB 25 using the intrinsic value
method. Consistent with industry practice, the Company elected the
prospective method of adopting fair value accounting.
During the three months ended March 31, 2007, approximately 5.6
million options were granted. In the first quarters of 2007 and 2006, the
Company recorded $14 million and $10 million of stock option expense.
The fair value of options granted in 2007 and 2006 were estimated at
the grant date using the following weighted average assumptions:
First Quarter
2007 2006
------ -------
Dividend yield 2.46% 2.44%
Expected volatility 23.35 21.94
Risk free interest rates 4.42 4.66
Expected options lives (in years) 6 5
In December 2004, the Financial Accounting Standards Board ("FASB")
issued SFAS No. 123 (revised 2004) ("SFAS 123(R)"), "Share-Based Payment,"
which is a
56
revision of SFAS No. 123, "Accounting for Stock-Based Compensation."
SFAS 123(R) eliminates the ability to account for share-based compensation
transactions using APB 25 and requires that such transactions be accounted
for using a fair value-based method. SFAS 123(R) covers a wide range of
share-based compensation arrangements including share options, restricted
share plans, performance-based awards, share appreciation rights, and employee
share purchase plans. The Company adopted SFAS 123(R) on January 1, 2006
using the "modified prospective" method. Under this method, compensation
cost is recognized beginning with the effective date (a) based on the
requirements of SFAS 123(R) for all share-based payments granted after the
effective date and (b) based on the requirements of SFAS 123 for all awards
granted to employees prior to the effective date of SFAS 123(R) that remain
unvested on the effective date. As of January 1, 2006, the Company was
amortizing all of its unvested stock option grants.
Certain of the Company's stock compensation grants vest when the
employee retires. SFAS 123(R) requires the completion of expensing of new
grants with this feature by the first date the employee is eligible to
retire. For grants prior to January 1, 2006, the Company will continue to
expense them over their stated vesting period. The adoption of SFAS 123(R)
increased pre-tax expense in 2006 by $12 million.
In February 2006, the FASB issued SFAS No. 155 ("SFAS 155"),
"Accounting for Certain Hybrid Financial Instruments", an amendment of SFAS
140 and SFAS 133. SFAS 155 permits the Company to elect to measure any
hybrid financial instrument at fair value if the hybrid instrument contains
an embedded derivative that otherwise would require bifurcation and be
accounted for separately under SFAS 133. SFAS 155 clarifies which
interest-only strips and principal-only strips are not subject to the
requirements of SFAS 133 and that concentrations of credit risk in the form
of subordination are not embedded derivatives. SFAS 155 is effective for
all financial instruments acquired, issued, or subject to a remeasurement
event after December 31, 2006. On January 17, 2007, the FASB issued
Derivative Implementation Groups ("DIG") Issue B40 which impacts how SFAS
155 is applied. The adoption of SFAS 155 and DIG Issue B40 did not have a
significant impact on the Company's investment activities.
In July 2006, the FASB issued FASB Staff Position ("FSP") FAS 13-2,
"Accounting for a Change or Projected Change in the Timing of Cash Flows
Relating to Income Taxes Generated by a Leverage Lease Transaction,"
revising the accounting guidance under SFAS No. 13 ("SFAS 13"), "Accounting
for Leases," for leveraged leases. This FSP modifies existing
interpretations of SFAS 13 and associated industry practice. As a result
in 2007, the Company recognized a one-time after-tax charge to equity of
$389 million related to a change in the timing of its lease cash flows due
to the LILO settlement. See "Commitments and Contingent Liabilities" in
Notes to Consolidated Financial Statements. However, an amount
approximating this one-time charge will be taken into income over the
remaining term of the affected leases. In the first quarter of 2007, the
Company recognized an after-tax income of $2 million. Since the Company
has not yet reached a settlement with the IRS related to LILOs originated
in 1998, the charge to equity was estimated assuming a December 31, 2007
settlement date. The portion of the one-time charge related to 1998 LILOs
will be taken into income between the settlement date and the end of the
lease term.
In September 2006, the FASB issued SFAS No. 157 ("SFAS 157"), "Fair
Value Measurements." SFAS 157 defines fair value, establishes a framework
for measuring fair value in accordance with generally accepted accounting
principles, and expands additional disclosures about fair value
measurements. SFAS 157 clarifies that fair value is the amount that would
be exchanged to sell an asset or transfer a liability, in an orderly
transaction between market participants. SFAS 157 nullifies the consensus
reached in EITF Issue No. 02-3 prohibiting the recognition of day one gain
or loss on derivative contracts (and hybrid instruments measured at fair
value under SFAS 133 as modified by SFAS 155) where the Company cannot
verify all of the significant model inputs to observable market data and
verify the model to market transactions. However, SFAS 157 requires that a
fair value measurement technique include an adjustment for risks inherent
in a particular valuation technique (such as a pricing
57
model) and/or the risks inherent in the inputs to the model if market
participants would also include such an adjustment. SFAS 157 will require the
Company to consider the effect of its own credit standing in determining the
fair value of its liabilities. In addition, SFAS 157 prohibits the recognition
of "block discounts" for large holdings of unrestricted financial instruments
where quoted prices are readily and regularly available in an active market.
The requirements of SFAS 157 are to be applied prospectively, except for
changes in fair value measurements that result from the initial application
of SFAS 157 to existing derivative financial instruments measured under
EITF Issue No. 02-3, existing hybrid instruments measured at fair value,
and block discounts, which are to be recorded as an adjustment to opening
retained earnings in the year of adoption. The Company expects to adopt
SFAS 157 on January 1, 2008. The Company is currently evaluating the impact
of SFAS 157.
In September 2006, the FASB issued SFAS No. 158, "Employers' Accounting
for Defined Benefit Pension and Other Postretirement Plans - an amendment of
FASB Statements No. 87, 88, 106 and 132(R)" ("SFAS 158"). SFAS 158 requires
the Company to (a) recognize in its statement of financial position an asset
for a plan's overfunded status or a liability for a plan's underfunded
status, (b) measure a plan's assets and its obligations that determine its
funded status as of the end of the fiscal year, (c) recognize changes in the
funded status of a defined postretirement plan in the year in which the
changes occur (reported in comprehensive income) and (d) provide additional
disclosure. The requirement to recognize the funded status of a benefit
plan and the disclosure requirements are effective as of the end of the
fiscal year ending after December 15, 2006. The requirement to measure the
plan assets and benefit obligations as of the date of the employer's fiscal
year-end statement of financial position is effective for fiscal years
ending after December 15, 2008. On December 31, 2006, the Company adopted
the recognition and disclosure provisions of SFAS 158. The adoption of
SFAS 158 resulted in a charge to equity of $264 million.
In 2007, the Company adopted FASB Interpretation No. 48, "Accounting
for Uncertainty in Income Taxes" ("FIN 48"). FIN 48 clarifies the
accounting for uncertain tax positions in accordance with SFAS No. 109,
"Accounting for Income Taxes." FIN 48 requires that a tax position meet a
"more-likely-than-not threshold" for the benefit of the uncertain tax
position to be recognized in the financial statements. A tax position that
fails to meet a more-likely-than-not recognition threshold will result in
either reduction of current or deferred tax assets, and/or recording of
current or deferred tax liabilities. The impact of adoption in 2007 was a
charge to equity of $27 million. See "Income Taxes" in the Notes to
Consolidated Financial Statements for further discussion related to FIN 48.
In February 2007, the FASB issued SFAS No. 159 ("SFAS 159"), "The Fair
Value Option for Financial Assets and Financial Liabilities." SFAS 159
provides companies with an option to report selected financial assets and
liabilities at fair value and to provide additional information that will
help investors and other users of financial statements to understand more
easily the effect on earnings of the company's choice to use fair value. It
also requires companies to display the fair value of those assets and
liabilities for which the company has chosen to use fair value on the face
of the balance sheet. The Company expects to adopt SFAS 159 along with SFAS
157 on January 1, 2008 and is currently evaluating the impact of SFAS 159.
Certain other prior year information has been reclassified to conform
its presentation with the 2007 financial statements.
3. Acquisitions and Dispositions
-----------------------------
The Company continues to be a selective acquirer of securities
servicing and asset management businesses.
In the first quarter of 2007, the Company acquired certain clearing
and custody relationships rights for cash. The Company frequently
structures its acquisitions with both an initial payment and a later
contingent payment tied to post-closing revenue or income growth. The
Company records the fair value
58
of contingent payments as an additional cost of the entity acquired in the
period that the payment becomes probable.
Goodwill and tax-deductible portion of goodwill related to completed
acquisitions in the first quarter of 2007 was zero. At March 31, 2007, the
Company was liable for potential contingent payments related to
acquisitions in the amount of $130 million. Cash paid or accrued for
acquisitions and contingent payments was $89 million in the first quarter
of 2007.
2007
----
In January 2007, certain clearing and custody relationships rights
were acquired by the Company's Pershing subsidiary. The transaction
involved 46 organizations, comprised of 30 registered investment advisor
firms and 16 introducing broker-dealer firms.
In March 2007, the Company sold its 49 percent stake in joint venture
BNY Mortgage Co. to EverBank Financial Corp. The transaction is consistent
with the Company's recent strategic moves to focus on asset management and
securities servicing.
In April 2007, the Company agreed to sell its 30% equity investment in
RBS International Securities Services (Holdings) Limited to BNP Paribas
Securities Services.
2006
----
On October 1, 2006, the Company sold its Retail Business to JPMorgan
Chase for the net asset value plus a premium of $2.3 billion. JPMorgan
Chase sold its corporate trust business to the Company for the net asset
value plus a premium of $2.15 billion. The difference between premiums
resulted in a net cash payment of $150 million to the Company. There is
also a contingent payment of up to $50 million to the Company tied to
customer retention. For further details, see "Discontinued Operations" in
the Notes to the Consolidated Financial Statements.
JPMorgan Chase's corporate trust business comprised issues
representing $5 trillion in total debt outstanding. It had 2,400 employees
in more than 40 locations globally. Prior to the acquisition, the
Company's corporate trust business comprised issues representing $3
trillion in total debt outstanding and had 1,300 employees in 25 locations
globally.
The Company's retail bank consisted of 338 branches in the Tri-State
region, serving approximately 700,000 consumer households and small
businesses with $13 billion in deposits and $9 billion in assets at
September 30, 2006. The Company's regional middle market businesses
provided financing, banking and treasury services for middle market
clients, serving more than 2,000 clients in the Tri-State region.
Together, the units had 4,000 employees located in New York, New Jersey,
Connecticut and Delaware.
The transaction further increases the Company's focus on the
securities services and wealth management businesses that have fueled the
Company's growth in recent years and that are at the core of its long-term
business strategy.
The Company recorded an after-tax gain of $1,381 million on the sale
of the Retail Business. The Company also expects to incur after-tax
charges of $150 million related to the acquisition. The transaction is
expected to be dilutive to GAAP earnings per share through 2009 (4.5
percent in 2007 to 1.5 percent in 2009), but to be accretive to cash
earnings per share in 2009 when cost savings are fully phased in.
59
On a pro forma basis, if the acquisition of the Acquired Corporate
Trust Business had occurred on January 1, 2006, the transaction would have
had the following impact:
For the three months ended
(Dollars in millions, March 31, 2006
except per share amounts) --------------------------
Reported Pro Forma
--------- ---------
Revenue $ 1,604 $ 1,810
Net income from continuing
operations 360 409
Net income 422 471
Diluted earnings per share
from continuing operations $ 0.47 $ 0.53
Diluted earnings per share 0.55 0.61
The pro forma results are based on adding the pre-tax historical
results of the Acquired Corporate Trust Business to the Company's results
and adjusting for amortization of intangibles created in the transaction
and taxes. The pro forma data does not include adjustments to reflect the
Company's operating costs or expected differences in the way funds
generated by the Acquired Corporate Trust Business are invested. The pro
forma data is intended for informational purposes and is not indicative of
the future results of operations.
The Company's transaction with JPMorgan Chase altered the composition
of the balance sheet. When the Acquired Corporate Trust Business is fully
integrated in 2007, approximately $14 billion of U.S. dollar retail
deposits will have been replaced with between $11 billion and $14 billion
of institutional corporate trust deposits. Between $7 billion and $10
billion of deposits related to the Acquired Corporate Trust Business have
not yet transitioned to the Company. These deposits will transition to the
Company as regulatory approval is received to operate in certain foreign
locations and as the novation process proceeds in other foreign locations.
The Company expects the transition will be substantially complete by June
30, 2007. Until the transition is complete, JPMorgan Chase will pay the
Company for the net economic value of these deposits. In the first quarter
of 2007, the Company recorded $25 million of net economic value payments in
noninterest income, compared with $23 million in the fourth quarter of
2006. On the asset side of the balance sheet, approximately $8 billion of
retail and middle market loans included in the sale of the Retail Business
have been replaced with liquid assets and securities. Goodwill and
intangibles related to the Acquired Corporate Trust Business were
approximately $2.3 billion.
On October 2, 2006, the Company completed the transaction resulting in
the formation of BNY ConvergEx Group. BNY ConvergEx Group brought together
BNY Securities Group's trade execution, commission management, independent
research and transition management business with Eze Castle Software, a
leading provider of trade order management and related investment
technologies. This transaction enabled the Company to achieve several
objectives including repositioning its execution services business for
faster growth and enhancing the product offering for the Company's client
base, while allowing the Company to withdraw capital committed to the
business.
BNY ConvergEx Group is a leading global agency brokerage and
technology company offering a complete spectrum of pre-trade, trade, and
post-trade solutions for traditional money managers, hedge funds, broker-
dealers, corporations and plan sponsors. BNY ConvergEx Group has a global
presence in New York, Boston, San Francisco, Chicago, Dallas, Stamford,
London, Bermuda, Tokyo, Hong Kong, and Sydney.
The Company and GTCR Golder Rauner, LLC each hold a 35 percent stake
in BNY ConvergEx Group, with the balance held by Eze Castle Software's
investors and BNY ConvergEx Group's management team. BNY ConvergEx Group,
with pro forma 2005 revenues of approximately $340 million, is an affiliate
of The Bank of New York and is reflected on the Company's financial
statements as an equity
60
investment. After the use of the proceeds to repurchase shares, the
transaction is expected to be neutral to earnings per share.
The BNY Securities Group businesses included in BNY ConvergEx Group
are BNY Brokerage, Lynch, Jones & Ryan, G-Port, Westminster Research and
BNY Jaywalk. In addition, The Bank of New York's B-Trade and G-Trade
businesses are expected to become part of BNY ConvergEx Group in 2008,
although in the interim they will continue to be owned by The Bank of New
York.
On December 1, 2006, the Company sold its transfer agency software
business, Rufus, to Bravura Solutions Limited ("Bravura"), a leading global
supplier of wealth management applications and professional services, for
approximately $38 million. Under the agreement, Bravura acquired all of the
software and intellectual property comprising Rufus, and all existing
employees will transfer to Bravura.
On December 3, 2006, the Company and Mellon entered into a definitive
agreement to merge, creating the world's largest securities servicing and
asset management firm. The new company, which will be called The Bank of
New York Mellon Corporation, will be the world's leading asset servicer
with Assets under Custody and Administration expected to exceed $18
trillion and the world's leading corporate trustee with assets under
trusteeship expected to exceed $8 trillion. It will rank among the top 10
global asset managers with assets under management expected to exceed $1.1
trillion.
The combined company is expected to have annual revenues of more than
$12 billion, with approximately 28% derived from asset servicing, 38% from
issuer services, clearing and execution services and treasury services, and
29% from asset and wealth management. By the end of 2008, the Company is
expected to generate over $1 billion tangible capital per quarter. It will
be well positioned to capitalize on global growth trends, including the
evolution of emerging markets, the growth of hedge funds and alternative
asset classes, the increasing need for more complex financial products and
services, and the increasingly global need for people to save and invest
for retirement. Almost a quarter of combined revenue will be derived
internationally.
Under the terms of the agreement, the Company's shareholders will
receive 0.9434 shares in the new company for each share of the Company that
they own and Mellon shareholders will receive one share in the new company
for each Mellon share they own.
To induce Mellon to enter into the merger agreement, the Company
granted Mellon an option to purchase up to 149,621,546 shares of the
Company's common stock at a price per share equal to the lesser of $35.48
and the closing sale price of the Company's common stock on the trading day
immediately preceding the exercise date; but in no case may Mellon acquire
more than 19.9% of the outstanding shares of the Company's common stock
under this stock option agreement. Mellon cannot exercise the option unless
specified triggering events occur. These events generally relate to
business combinations or acquisition transactions involving the Company and
a third party.
The option could have the effect of discouraging a third party from
trying to acquire the Company prior to completion of the transaction or
termination of the merger agreement. Upon the occurrence of certain
triggering events, the Company may be required to repurchase the option
and/or any shares of the Company's common stock purchased by Mellon under
the option at a predetermined price, or Mellon may choose to surrender the
option to the Company for a cash payment of $1.15 billion. In no event will
the total profit received by Mellon with respect to this option exceed $1.3
billion.
To induce the Company to enter into the merger agreement, Mellon
granted the Company an option to purchase up to 82,641,656 shares of Mellon
common stock at a price per share equal to the lesser of $40.05 and the
closing sale price of Mellon common stock on the trading day immediately
preceding the exercise date; but in no case may the Company acquire more
than 19.9% of the outstanding shares of Mellon common stock under this
stock option agreement. The Company cannot exercise the option unless
specified triggering events
61
occur. These events generally relate to business combinations or acquisition
transactions involving Mellon and a third party.
The option could have the effect of discouraging a third party from
trying to acquire Mellon prior to completion of the transaction or
termination of the merger agreement. Upon the occurrence of certain
triggering events, Mellon may be required to repurchase the option and/or
any shares of Mellon common stock purchased by the Company under the option
at a predetermined price, or the Company may choose to surrender the option
to Mellon for a cash payment of $725 million. In no event will the total
profit received by the Company with respect to this option exceed $825
million.
On December 19, 2006, the Company acquired the remaining 50% stake in
AIB/BNY Securities Services (Ireland) Ltd. (AIB/BNY) that it did not own
from Allied Irish Banks, p.l.c. ("AIB"). AIB/BNY was established in 1995 as
a joint venture between AIB and the Company to provide a range of services
for a number of fund structures domiciled in Ireland. At acquisition,
AIB/BNY had $210 billion assets under administration and employed 600 staff
in its Dublin and Cork offices.
4. Discontinued Operations
-----------------------
On October 1, 2006, the Company acquired JPMorgan Chase's corporate
trust business and JPMorgan Chase acquired the Company's Retail Business.
The Company adopted discontinued operations accounting for its Retail
Business. Also included in the sales agreement are provisions related to
transitional services that will be provided for a period of up to 8 months
after closing, subject to extensions. The results from continuing
operations exclude the results of the Company's Retail Business and include
the operations of the Acquired Corporate Trust Business only after October
1, 2006.
Results for all the Retail Business are reported separately as
discontinued operations for all periods presented. The assets and
liabilities of the businesses sold are included in assets of discontinued
operations held for sale and liabilities of discontinued operations held
for sale on the consolidated balance sheet. Net interest income has been
computed by allocating investment securities and federal funds sold and
related interest income to discontinued operations to match the amount and
duration of the assets sold with the amount and duration of the liabilities
sold.
Summarized financial information for discontinued operations related
to the Retail Business is as follows:
(In millions) 1Q07 4Q06 1Q06
------ ------ ------
Noninterest income(1) $ 14 $2,174 $ 71
Net interest income - - 149
------ ------ ------
Total revenue,
net of interest expense $ 14 $2,174 $ 220
====== ====== ======
Income (loss) from
discontinued operations(1) $ (5) $2,130 $ 102
Income taxes (benefits) (2) 768 40
------ ------ ------
Income (loss) from
discontinued operations,
Net of taxes $ (3) $1,362 $ 62
====== ====== ======
(1) Including the $2,159 million pre-tax gain on the sale of the Retail
Business in the fourth quarter of 2006.
Assets and liabilities of discontinued operations held for sale as of
March 31, 2007 and December 31, 2006 were not significant.
62
5. Goodwill and Intangibles
------------------------
Goodwill by reportable segment is as follows:
(In millions)
March 31, 2007 December 31, 2006
------------------ -----------------
Asset and wealth management $ 622 $ 605
Institutional services 4,509 4,567
------------------ -----------------
Consolidated total $ 5,131 $ 5,172
================== =================
The changes in goodwill during the first quarter of 2007 were as follows:
(In millions)
Balance at December 31, 2006 $ 5,172
Acquisitions 8
Foreign exchange translation 2
Other (1) (51)
--------
Balance at March 31, 2007 $ 5,131
========
(1) Other changes in goodwill include purchase price adjustments and certain
other reclassifications.
The Company's reporting units are tested annually for goodwill
impairment.
Intangible Assets
-----------------
March 31, 2007 December 31, 2006
---------------------------------------------- ------------------------------
Weighted
Gross Net Average Gross Net
Carrying Accumulated Carrying Amortization Carrying Accumulated Carrying
(Dollars in millions) Amount Amortization Amount Period in Years Amount Amortization Amount
-------- ------------ -------- --------------- -------- ------------ --------
Trade names $ 370 $ - $ 370 Indefinite Life $ 370 $ - $ 370
Customer relationships 1,253 (176) 1,077 13 1,231 (148) 1,083
Other intangible
assets 8 (8) - - 17 (17) -
The aggregate amortization expense of intangibles was $28 million and
$13 million for the quarters ended March 31, 2007 and 2006, respectively.
Estimated amortization expense for current intangibles for the next five
years is as follows:
For the Year Ended Amortization
(In millions) December 31, Expense
------------------ ------------
2007 $114
2008 114
2009 112
2010 111
2011 111
63
6. Allowance for Credit Losses
---------------------------
The allowance for credit losses is maintained at a level that, in
management's judgment, is adequate to absorb probable losses associated
with specifically identified loans, as well as estimated probable credit
losses inherent in the remainder of the credit portfolio at the balance
sheet date. Management's judgment includes the following factors, among
others: risks of individual credits; past experience; the volume,
composition, and growth of the credit portfolio; and economic conditions.
The Company conducts a quarterly portfolio review to determine the
adequacy of its allowance for credit losses. All commercial loans over $1
million are assigned to specific risk categories. Smaller commercial and
consumer exposures are evaluated on a pooled basis and assigned to specific
risk categories. Following this review, senior management of the Company
analyzes the results and determines the allowance for credit losses. The
Company's Board of Directors reviews the allowance at the end of each
quarter.
The portion of the allowance for credit losses allocated to impaired
loans (nonaccrual commercial loans over $1 million) is measured by the
difference between their recorded value and fair value. Fair value is
determined by one of the following: present value of the expected future
cash flows from borrowers, the market value of the loan, or the fair value
of the collateral. See "Critical Accounting Policies" and "Allowance" in
the MD&A section for additional information.
Commercial loans are placed on nonaccrual status when collateral is
insufficient and principal or interest is past due 90 days or more, or when
there is reasonable doubt that interest or principal will be collected.
Accrued interest is usually reversed when a loan is placed on nonaccrual
status. Interest payments received on nonaccrual loans may be recognized
as income or applied to principal depending upon management's judgment.
Nonaccrual loans are restored to accrual status when principal and interest
are current or they become fully collateralized. Consumer loans are not
classified as nonperforming assets, but are charged off and interest
accrued is suspended based upon an established delinquency schedule
determined by product. Real estate acquired in satisfaction of loans is
carried in other assets at the lower of the recorded investment in the
property or fair value minus estimated costs to sell.
Transactions in the allowance for credit losses are summarized as
follows:
(In millions) Three Months Ended March 31, 2007
----------------------------------------------
Allowance for
Allowance for Lending-Related Allowance for
Loan Losses Commitments Credit Losses
-------------- --------------- -------------
Balance, beginning of period $ 287 $ 150 $ 437
Charge-offs - (5) (5)
Recoveries 8 - 8
-------------- --------------- -------------
Net (charge-offs)/recoveries 8 (5) 3
Provision (5) (10) (15)
-------------- --------------- -------------
Balance, end of period $ 290 $ 135 $ 425
============== =============== =============
64
(In millions) Three Months Ended March 31, 2006
----------------------------------------------
Allowance for
Allowance for Lending-Related Allowance for
Loan Losses Commitments Credit Losses
-------------- --------------- -------------
Balance, beginning of period $ 326 $ 144 $ 470
Charge-offs (2) - (2)
Recoveries 6 - 6
-------------- --------------- -------------
Net (charge-offs)/recoveries 4 - 4
Provision 4 (4) -
-------------- --------------- -------------
Balance, end of period $ 334 $ 140 $ 474
============== =============== =============
7. Other Assets
------------
March 31, December 31,
(In millions) 2007 2006
------------- --------- ----------
Accounts and interest receivable $ 2,621 $ 3,443
Fails to deliver 1,136 1,523
Other investments 963 857
Prepaid pension assets 624 635
Software 387 388
Margin deposits 494 324
Prepaid expenses 250 223
Due from customers on acceptances 285 213
Other 2,301 2,367
--------- ----------
Total other assets $ 9,061 $ 9,973
========= ==========
8. Net Interest Income
-------------------
Quarter Ended
(In millions) ---------------------------------
March 31, December 31, March 31,
2007 2006 2006
------ ------ -------
Interest Income
---------------
Loans $ 407 $ 422 $ 310
Margin loans 84 83 77
Securities
Taxable 293 274 265
Exempt from federal income taxes 1 1 9
------ ------ ------
294 275 274
Deposits in banks 146 167 86
Federal funds sold and securities purchased
under resale agreements 57 78 15
Trading assets 33 32 51
------ ------ ------
Total interest income 1,021 1,057 813
------ ------ ------
Interest Expense
----------------
Deposits 400 397 298
Federal funds purchased and securities sold
under repurchase agreements 19 16 20
Other borrowed funds 13 30 20
Customer payables 42 43 40
Long-term debt 120 120 96
------ ------ ------
Total interest expense 594 606 474
------ ------ ------
Net interest income $ 427 $ 451 $ 339
====== ====== ======
65
9. Capital Transactions
--------------------
The Company has 5 million authorized shares of Class A convertible
preferred stock having a par value of $2.00 per share. At December 31,
2006, 3,000 shares were outstanding. On January 22, 2007, the Company
redeemed 300 shares of Class A convertible preferred stock at a per share
redemption price of $25 plus accrued dividends of $11.03. The remaining
2,700 shares were converted into Company common stock with shareholders
receiving 7.39644 shares of Company common stock for each share of Class A
convertible preferred stock.
In addition to the Class A preferred stock, the Company has 5 million
authorized shares of preferred stock having no par value, with no shares
outstanding at March 31, 2007 and December 31, 2006, respectively.
On April 10, 2007, the Board of Directors declared a quarterly
dividend of 22 cents per share payable May 4, 2007 to shareholders of
record on April 25, 2007.
The Company repurchased 363,080 shares of the Company's common stock
in the first quarter of 2007.
10. Earnings Per Share
------------------
The following table illustrates the computations of basic and diluted
earnings per share:
(In millions, Three Months Ended
except per share amounts) March 31,
------------------
2007 2006
-------- --------
Income from continuing operations $ 437 $ 360
Income (loss) from
discontinued operations (3) 62
-------- --------
Net income (1) $ 434 $ 422
======== ========
Basic weighted average
shares outstanding 751 764
Shares issuable upon conversion
of employee stock options 12 10
-------- --------
Diluted weighted average
shares outstanding 763 774
======== ========
Basic earnings per share:
Income from continuing operations $ 0.58 $ 0.47
Income from discontinued operations - 0.08
Net income 0.58 0.55
Diluted earnings per share:
Income from continuing operations $ 0.57 $ 0.47
Income from discontinued operations - 0.08
Net income 0.57 0.55
(1) Net income, net income available to common shareholders and diluted net income are
the same for all periods presented.
66
11. Employee Benefit Plans
----------------------
The components of net periodic benefit cost are as follows:
Pension Benefits Healthcare Benefits
------------------- -------------------
Three Months Ended Three Months Ended
March 31, March 31,
------------------- ------------------
Domestic Foreign Domestic
--------- --------- ------------------
(In millions) 2007 2006 2007 2006 2007 2006
--------------------- ---- ---- ---- ---- ----- -----
Net periodic cost (income)
Service cost $ 10 $ 12 $ 2 $ 2 $ - $ -
Interest cost 12 13 3 3 3 2
Expected return on assets (26) (25) (4) (3) (1) (1)
Other 5 9 1 1 2 3
---- ---- ---- ---- ----- -----
Net periodic cost
(income)(1) $ 1 $ 9 $ 2 $ 3 $ 4 $ 4
==== ==== ==== ==== ===== =====
(1) Pension benefits expense includes discontinued operations expense $1.5 million for the three
months ended March 31, 2006.
12. Income Taxes
------------
The statutory federal income tax rate is reconciled to the Company's
effective income tax rate below:
Three Months Ended
March 31,
------------------
2007 2006
------ ------
Federal rate 35.0% 35.0%
State and local income taxes,
net of federal income tax benefit 3.0 2.2
Nondeductible expenses 0.1 0.2
Credit for synthetic fuel investments (1.2) (1.0)
Credit for low-income housing investments (1.2) (1.9)
Tax-exempt income from municipal securities (0.1) (0.1)
Other tax-exempt income (1.0) (1.2)
Foreign operations (0.7) (0.9)
Leveraged lease portfolio (1.1) (0.1)
Tax reserve - LILO exposure 0.1 0.6
Other - net (0.7) (0.1)
------ ------
Effective rate 32.2% 32.7%
====== ======
The Company adopted the provisions of FASB Interpretation No. 48 ("FIN
48"), "Accounting for Uncertainty in Income Taxes - an interpretation of FASB
Statement No. 109," on January 1, 2007. As a result of the implementation of
FIN 48, the Company recognized a $27 million increase in its liability for
uncertain tax benefits ("Tax Reserves"), which reduced the January 1, 2007,
retained earnings balance. The Company's total Tax Reserves as of the date
of adoption were $250 million. If these Tax Reserves were unnecessary, $174
million would affect the effective tax rate in future periods and $76 million
would impact deferred taxes. Included in the above Tax Reserves is accrued
interest and penalties, where applicable, of $31 million. The Company
recognizes accrued interest and penalties, if applicable, related to income
taxes in income tax expense.
The Company's federal consolidated income tax returns are closed to
examination through 1995. Although the IRS has completed its examination for
1996 and 1997, at this time a formal revenue agent's report has not been
received. The Company believes it is unlikely that there will be any changes
to those years that would affect the Tax Reserves. The IRS is currently
examining the Company's
67
consolidated income tax returns for tax years 1998 through 2002. The
Company's New York State and New York City return examinations have been
completed through 1993. New York State and New York City are currently
examining the Company's tax returns for the years 1994 through 1996.
The Company's United Kingdom income tax returns are closed through 1999.
The Company has Tax Reserves related to transactions occurring in the
years 1998 through 2002 that are currently under examination by the IRS. The
outcome of such examination is not yet determinable. Additionally, the
Company has Tax Reserves for uncertain tax benefits associated with certain
tax credits. The Company does not expect that the resolution of these and
other issues over the next twelve months will have a material impact on its
financial statements.
13. Derivatives and Hedging Relationships
-------------------------------------
Derivative contracts, such as futures contracts, forwards, interest
rate swaps, foreign currency swaps and options and similar products used in
trading activities, are recorded at fair value. The Company does not
recognize gains or losses at the inception of derivative transactions if
the fair value is not determined based upon observable market transactions
and market data. Gains and losses are included in foreign exchange and
other trading activities in noninterest income. Unrealized gains and
losses are reported on a gross basis in trading account assets and trading
liabilities, after taking into consideration master netting agreements.
The Company enters into various derivative financial instruments for
non-trading purposes primarily as part of its asset/liability management
("ALM") process. These derivatives are designated as fair value and cash
flow hedges of certain assets and liabilities when the Company enters into
the derivative contracts. Gains and losses associated with fair value
hedges are recorded in income as well as any change in the value of the
related hedged item. Gains and losses on cash flow hedges are recorded in
other comprehensive income. If a derivative used in ALM does not qualify
as a hedge it is marked to market and the gain or loss is included in net
interest income.
The Company formally documents all relationships between hedging
instruments and hedged items, as well as its risk-management objectives and
strategy for undertaking various hedge transactions. This process includes
linking all derivatives that are designated as fair value hedges to
specific assets or liabilities on the balance sheet.
The Company formally assesses both at the hedge's inception and on an
ongoing basis whether the derivatives that are used in hedging transactions
are highly effective and whether those derivatives are expected to remain
highly effective in future periods. The Company evaluates ineffectiveness
in terms of amounts that could impact a hedge's ability to qualify for
hedge accounting and the risk that the hedge could result in more than a de
minimus amount of ineffectiveness. At inception, the potential causes of
ineffectiveness related to each of its hedges is assessed to determine if
the Company can expect the hedge to be highly effective over the life of
the transaction and to determine the method for evaluating effectiveness on
an ongoing basis. Recognizing that changes in the value of derivatives
used for hedging or the value of hedged items could result in significant
ineffectiveness, the Company has processes in place designed to identify
and evaluate such changes when they occur. Quarterly, the Company performs
a quantitative effectiveness assessment and records any ineffectiveness.
The Company utilizes interest rate swap agreements to manage its
exposure to interest rate fluctuations. For hedges of fixed-rate loans,
asset-backed securities, deposits and long-term debt, the hedge
documentation specifies the terms of the hedged items and interest rate
swaps and indicates that the derivative is hedging a fixed rate item and is
a fair value hedge, that the hedge exposure is to the changes in the fair
value of the hedged item due to changes in benchmark interest rates, and
that the strategy is to eliminate fair value variability by converting
fixed rate interest payments to LIBOR.
68
The fixed-rate loans hedged generally have a maturity of 9 to 12 years
and are not callable. These loans are hedged with "pay fixed rate, receive
variable rate" swaps with similar notional amounts, maturities, and fixed
rate coupons. The swaps are not callable. At March 31, 2007, $42 million
of loans were hedged with interest rate swaps which had notional values of
$42 million.
The securities hedged generally have a weighted average life of 10
years or less and are callable six months prior to maturity. These
securities are hedged with pay fixed rate, receive variable rate swaps of
like maturity, repricing and fixed-rate coupon. The swaps are callable six
months prior to maturity. At March 31, 2007, $227 million of securities
were hedged with interest rate swaps which had notional values of $227
million.
The fixed-rate deposits hedged generally have original maturities of 1
to 12 years (21% are one year deposits) and, except for three deposits, are
not callable. These deposits are hedged with receive fixed rate, pay
variable rate swaps of similar maturity, repricing and fixed rate coupon.
The swaps are not callable except for the three that hedge the callable
deposits. At March 31, 2007, $880 million of deposits were hedged with
interest rate swaps which had notional values of $880 million.
The fixed-rate long-term debt hedged generally has an original
maturity of 4 to 30 years. The Company issues both callable and non-
callable debt. The non-callable debt is hedged with simple interest rate
swaps similar to those described for deposits. Callable debt is hedged
with callable swaps where the call dates of the swaps exactly match the
call dates of the debt. At March 31, 2007, $6,212 million of debt was
hedged with interest rate swaps which had notional values of $6,237
million.
In addition to the fair value hedges discussed above, the Company has
two cash flow hedges utilizing interest rate swaps to hedge the variability
in expected future cash flows attributable to floating rates on an a
deposit and a long-term debt issue. The hedge documentation specifies the
terms of the hedged items and interest rate swaps and indicates that the
derivative is hedging future variable interest payments and is a cash flow
hedge, that the hedge exposure is the variability in interest payments, and
that the strategy is to eliminate variability by converting floating rate
interest payments to fixed payments. For cash flow hedges the interest
rate swap is marked to market with the changes in value recorded in other
comprehensive income. The amount recognized as other comprehensive income
for the cash flow hedge is reclassified to net interest income as interest
is realized on the hedged item.
The deposit hedged has a principal amount of $275 million and has a
LIBOR based floating rate and an 18 month original maturity. The deposit is
hedged with a receive LIBOR, pay fixed rate swap with the same maturity and
interest payment dates as the deposit to eliminate the variability in
interest payments on the deposit. During the next twelve months, net
losses of less than $1 million (pre-tax) included in other comprehensive
income are expected to be reclassified to income.
The long-term debt hedged has a principal amount of $400 million and
has a LIBOR based floating rate and a 2 year original maturity. The debt is
hedged with a receive LIBOR, pay fixed rate swap with the same maturity and
interest payment dates as the debt to eliminate the variability in interest
payments on the debt. During the next twelve months, net losses of less
than $2 million (pre-tax) included in other comprehensive income are
expected to be reclassified to income.
In addition, the Company enters into foreign exchange hedges. The
Company uses forward foreign exchange contracts with maturities of 12
months or less to hedge its Sterling and Euro foreign exchange exposure
with respect to forecasted expense transactions in non-U.S. entities which
have the U.S. dollar as their functional currency. As of March 31, 2007,
the hedged forecasted foreign currency transactions and linked foreign
exchange forward hedges were $93 million with $3 million (pre-tax) gains
recorded in other comprehensive income. These gains are expected to be
reclassified to expense over the next nine months.
69
Forward foreign exchange contracts are also used to hedge the value of
the Company's investments in foreign subsidiaries. These forward contracts
have a maturity of less than six months. The derivatives employed are
designated as net investment hedges of changes in value of the Company's
foreign investment due to exchange rates, such that changes in value of the
forward exchange contracts offset the changes in value of the foreign
investments due to changes in foreign exchange rates. The change in fair
market value of these contracts is deferred and reported within accumulated
translation adjustments in shareholders' equity, net of tax effects. At
March 31, 2007, foreign exchange contracts, with notional amounts totaling
$1,894 million, were designated as hedges of corresponding amounts of net
investments.
The Company discontinues hedge accounting prospectively when it
determines that a derivative is no longer an effective hedge, the
derivative expires or is sold, or management discontinues the derivative's
hedge designation.
Ineffectiveness related to derivatives and hedging relationships was
recorded in income as follows:
(In millions) Three Months Ended March 31,
Hedges 2007 2006
------------------------- ----------- -----------
Fair value hedge of loans $ (0.1) $ 0.2
Fair value hedge
of securities 0.1 -
Fair value hedge of deposits
and long-term debt (0.5) 0.5
Cash flow hedges (0.5) (0.2)
Other - (0.3)
----------- -----------
Total $ (1.0) $ 0.2
=========== ===========
Other includes ineffectiveness recorded on foreign exchange hedges.
14. Commitments and Contingent Liabilities
--------------------------------------
In the normal course of business, various commitments and contingent
liabilities are outstanding which are not reflected in the accompanying
consolidated balance sheets. Management does not expect any material
losses to result from these matters.
The Company's significant trading and off-balance sheet risks are
securities, foreign currency and interest rate risk management products,
commercial lending commitments, letters of credit, and securities lending
indemnifications. The Company assumes these risks to reduce interest rate
and foreign currency risks, to provide customers with the ability to meet
credit and liquidity needs, to hedge foreign currency and interest rate
risks, and to trade for its own account. These items involve, to varying
degrees, credit, foreign exchange, and interest rate risk not recognized in
the balance sheet. The Company's off-balance sheet risks are managed and
monitored in manners similar to those used for on-balance sheet risks.
There are no significant industry concentrations of such risks.
A summary of the notional amount of the Company's off-balance sheet
credit transactions, net of participations, at March 31, 2007 and December
31, 2006 follows:
Off-Balance Sheet Credit Risks
------------------------------
March 31, December 31,
(In millions) 2007 2006
----------------------------------- ------------ -----------
Lending commitments $ 37,530 $ 37,364
Standby letters of credit 10,410 10,902
Commercial letters of credit 1,064 1,195
Securities lending indemnifications 396,722 398,675
70
The total potential loss on undrawn commitments, standby and
commercial letters of credit, and securities lending indemnifications is
equal to the total notional amount if drawn upon, which does not consider
the value of any collateral. Since many of the commitments are expected to
expire without being drawn upon, the total amount does not necessarily
represent future cash requirements. The allowance for lending-related
commitments at March 31, 2007 and December 31, 2006 was $135 million and
$150 million.
A securities lending transaction is a fully collateralized transaction
in which the owner of a security agrees to lend the security through an
agent (the Company) to a borrower, usually a broker/dealer or bank, on an
open, overnight or term basis, under the terms of a prearranged contract,
which generally matures in less than 90 days. The Company generally lends
securities with indemnification against broker default. The Company
generally requires the borrower to provide 102% cash collateral which is
monitored on a daily basis, thus reducing credit risk. Security lending
transactions are generally entered into only with highly-rated
counterparties. At March 31, 2007 and December 31, 2006, securities
lending indemnifications were secured by collateral of $407.3 billion and
$405.5 billion, respectively.
Standby letters of credit principally support corporate obligations
and include $1.1 billion that were collateralized with cash and securities
on March 31, 2007 and $1.0 billion on December 31, 2006. At March 31,
2007, approximately $6.8 billion of the standby letters of credit will
expire within one year, and the remaining balance will expire between one
to five years.
The notional amounts for other off-balance sheet risks (See "Trading
Activities" in the MD&A section) express the dollar volume of the
transactions; however, credit risk is much smaller. The Company performs
credit reviews and enters into netting agreements to minimize the credit
risk of foreign currency and interest rate risk management products. The
Company enters into offsetting positions to reduce exposure to foreign
exchange and interest rate risk.
Other
-----
The Company has provided standard representations for underwriting
agreements, acquisition and divestiture agreements, sales of loans and
commitments, and other similar types of arrangements and customary
indemnification for claims and legal proceedings related to its provision
of financial services. Insurance has been purchased to mitigate certain of
these risks. The Company is a minority equity investor in, and member of,
several industry clearing or settlement exchanges through which foreign
exchange, securities, or other transactions settle. Certain of these
industry clearing or settlement exchanges require their members to
guarantee their obligations and liabilities or to provide financial support
in the event other partners do not honor their obligations. It is not
possible to estimate a maximum potential amount of payments that could be
required with such agreements.
In the ordinary course of business, the Company makes certain
investments that have tax consequences. From time to time, the IRS may
question or challenge the tax position taken by the Company. The Company
engaged in certain types of structured cross-border leveraged leasing
investments, referred to as "LILOs", prior to mid-1999 that the IRS has
challenged. In 2004, the IRS proposed adjustments to the Company's tax
treatment of these transactions. On February 28, 2006, the Company settled
this matter with the IRS relating to LILO transactions closed in 1996 and
1997. The settlement did not affect 2006 net income, as the impact of the
settlement was fully reserved.
The Company's 1998 leveraged lease transactions are in a subsequent
audit cycle and were not part of the settlement. The Company believes that
a comparable settlement for 1998 may be possible, given the similarity
between these leases and the settled leases. However, negotiations are
ongoing and the treatment of the 1998 leases may still be litigated if an
acceptable settlement cannot be reached. Under current U.S. generally
accepted accounting principles, if the 1998 leases are settled on a basis
comparable to the 1996 and 1997 leases, the Company would not expect the
settlement of the 1998 leases to have an impact on net income, based on
existing reserves.
71
In the fourth quarter of 2005 the Company deposited funds with the IRS
in anticipation of reaching a settlement on all of its LILO investments.
On February 11, 2005, the IRS released Notice 2005-13, which
identified certain lease investments known as "SILOs" as potentially
subject to IRS challenge. The Company believes that certain of its lease
investments entered into prior to 2004 may be consistent with transactions
described in the notice. Although it is likely the IRS will challenge the
tax benefits associated with these leases in 2007, the Company remains
confident that its tax treatment of the leases complied with statutory,
administrative and judicial authority existing at the time they were
entered into.
In 2001 and 2002, the Company entered into various structured
transactions that involved, among other things, the payment of U.K.
corporate income taxes that were credited against the Company's U.S.
corporate income tax liability. The IRS is currently reviewing these
transactions and it is likely that some or all of the credits will be
challenged upon completion of the review. If necessary the Company will
vigorously defend its position and believes that any tax benefits
associated with these transactions were consistent with the applicable
statutory, judicial and administrative authority.
The Company currently believes it has adequate tax reserves to cover
its LILO exposure and any other potential tax exposures, based on a
probability assessment of various potential outcomes. Probabilities and
outcomes are reviewed as events unfold, and adjustments to the reserves are
made when appropriate.
In the ordinary course of business, the Company and its subsidiaries
are routinely defendants in or parties to a number of pending and potential
legal actions, including actions brought on behalf of various classes of
claimants, and regulatory matters. Claims for significant monetary damages
are asserted in certain of these actions and proceedings. Due to the
inherent difficulty of predicting the outcome of such matters, the Company
cannot ascertain what the eventual outcome of these matters will be;
however, based on current knowledge and after consultation with legal
counsel, the Company does not believe that judgments or settlements, if
any, arising from pending or potential legal actions or regulatory matters,
either individually or in the aggregate, after giving effect to applicable
reserves, will have a material adverse effect on the consolidated financial
position or liquidity of the Company although they could have a material
effect on net income for a given period. The Company intends to defend
itself vigorously against all of the claims asserted in these legal
actions.
See discussion of contingent legal matters in the "Legal and
Regulatory Proceedings" section.
72
QUARTERLY REPORT ON FORM 10-Q
THE BANK OF NEW YORK COMPANY, INC.
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the quarterly period ended March 31, 2007
Commission file number 001-06152
THE BANK OF NEW YORK COMPANY, INC.
Incorporated in the State of New York
I.R.S. Employer Identification No. 13-2614959
Address: One Wall Street
New York, New York 10286
Telephone: (212) 495-1784
As of April 30, 2007, The Bank of New York Company, Inc. had
758,522,492 shares of common stock ($7.50 par value) outstanding.
The Bank of New York Company, Inc. (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months(or such shorter period that the registrant was required to
file such reports), and (2) has been subject to such filing requirements for
the past 90 days.
The registrant is a large accelerated filer (as defined in Rule 12b-2 of the
Exchange Act).
The registrant is not a shell company (as defined in Rule 12b-2 of the
Exchange Act).
The following sections of the Financial Review set forth in the cross-
reference index are incorporated in the Quarterly Report on Form 10-Q.
Cross-reference Page(s)
-----------------------------------------------------------------------------
PART I FINANCIAL INFORMATION
Item 1 Financial Statements
Consolidated Balance Sheets as of
March 31, 2007 and December 31, 2006 51
Consolidated Statements of Income for
the Three Months Ended March 31, 2007,
December 31, 2006 and March 31, 2006 52
Consolidated Statement of Changes in Shareholders'
Equity for the Three Months Ended March 31, 2007 53
Consolidated Statement of Cash Flows
for the Three Months Ended March 31, 2007 and 2006 54
Notes to Consolidated Financial Statements 55 - 71
Item 2 Management's Discussion and Analysis of
Financial Condition and Results of Operations 3 - 50
Item 3 Quantitative and Qualitative Disclosures
About Market Risk 42 - 44
73
ITEM 4. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
The Company's Disclosure Committee, whose members include the Chief
Executive Officer and Chief Financial Officer, has responsibility for
ensuring that there is an adequate and effective process for establishing,
maintaining, and evaluating disclosure controls and procedures that are
designed to ensure that information required to be disclosed by the Company
in its SEC reports is timely recorded, processed, summarized and reported.
In addition, the Company's ethics hotline can also be used by employees for
the anonymous communication of concerns about financial controls or
reporting matters. There are inherent limitations to the effectiveness of
any system of disclosure controls and procedures, including the possibility
of human error and the circumvention or overriding of the controls and
procedures. Accordingly, even effective disclosure controls and procedures
can only provide reasonable assurance of achieving their control
objectives.
As of the end of the period covered by this report, an evaluation was
carried out under the supervision and with the participation of the
Company's management, including the Chief Executive Officer and Chief
Financial Officer, of the effectiveness of the Company's disclosure
controls and procedures as defined in Exchange Act Rule 13a-15(e) and 15d-
15(e). Based on that evaluation, the Chief Executive Officer and Chief
Financial Officer concluded that the Company's disclosure controls and
procedures were effective.
Changes in Internal Control Over Financial Reporting
In the ordinary course of business, the Company may routinely modify,
upgrade or enhance its internal controls and procedures for financial
reporting. There have not been any changes in the Company's internal
controls over financial reporting as defined in Exchange Act Rule 13a-15(f)
and 15d-15(f) during the fiscal quarter to which this report relates that
have materially affected, or are reasonably likely to materially affect,
the Company's internal control over financial reporting.
PART II. OTHER INFORMATION
ITEM 1. LEGAL AND REGULATORY PROCEEDINGS
In the ordinary course of business, the Company and its subsidiaries
are routinely defendants in or parties to a number of pending and potential
legal actions, including actions brought on behalf of various classes of
claimants, and regulatory matters. Claims for significant monetary damages
are asserted in certain of these actions and proceedings. In regulatory
enforcement matters, claims for disgorgement and the imposition of
penalties and/or other remedial sanctions are possible. Due to the
inherent difficulty of predicting the outcome of such matters, the Company
cannot ascertain what the eventual outcome of these matters will be;
however, on the basis of current knowledge and after consultation with
legal counsel, the Company does not believe that judgments or settlements,
if any, arising from pending or potential legal actions or regulatory
matters, either individually or in the aggregate, after giving effect to
applicable reserves, will have a material adverse effect on the
consolidated financial position or liquidity of the Company, although they
could have a material effect on net income for a given period. The Company
intends to defend itself vigorously against all of the claims asserted in
these legal actions.
As previously disclosed in the Company's 2006 Annual Report on Form
10-K, the U.S. Securities and Exchange Commission ("SEC") is investigating
1) the appropriateness of certain expenditures made in connection with
marketing and distribution of the Hamilton Funds; 2) possible market-timing
transactions cleared by Pershing LLC ("Pershing"); and 3) the trading
activities of Pershing Trading Company LP, a floor specialist, on two
regional exchanges from 1999 to 2004. As to market-timing, the Company has
learned that the SEC is considering not pursuing the matter further.
74
Because the conduct at issue in the Pershing market timing and floor
specialist investigations is alleged to have occurred largely during the
period when Pershing was owned by Credit Suisse First Boston (USA), Inc.
("CSFB"), the Company has made claims for indemnification against CSFB
relating to these matters under the agreement relating to the acquisition
of Pershing. CSFB is disputing these claims for indemnification.
ITEM 1A. RISK FACTORS
See "Forward-Looking Statements and Risk Factors" in "Management's
Discussion and Analysis of Financial Condition and Results of
Operations." There have been no material changes to the risk factors
discussed in the Company's Annual Report on Form 10-K for the year ended
December 31, 2006.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES
AND USE OF PROCEEDS
Shares of the Company's common stock were issued in the following
transactions exempt from registration under the Securities Act of 1933
pursuant to Section 4(2) thereof:
(a) Shares of common stock were issued to former directors who had deferred
receipt of such common stock pursuant to the Deferred Compensation Plan
for Non-Employee Directors of The Bank of New York Company, Inc.
On March 13, 2007, 7,872 shares of common stock were issued to
three current directors as part of their annual retainer as non-
employee directors. Richard J. Kogan, John A. Luke, Jr. and Richard
C. Vaughan each received 2,624 shares.
These transactions were exempt from registration under the
Securities Act of 1933 pursuant to Section 4(2).
(c) Under its stock repurchase program, the Company buys back shares
from time to time. The following table discloses the Company's
repurchases of the Company's common stock made during the first
quarter of 2007.
Issuer Purchases of Equity Securities
-------------------------------------
Total Number Maximum
Total Average of Shares Number of Shares
Number Price Purchased as That May be
Period of Shares Paid Part of Repurchased
Purchased Per Share Publicly Under the Plans
Announced Plans or Programs
or Programs
-------------- ---------- ---------- --------------- ------------------
January 1-31 148,423 $ 38.38 148,423 7,973,562
February 1-28 211,620 41.46 211,620 7,761,942
March 1-31 3,037 39.37 3,037 7,758,905
---------- ---------------
Total 363,080 363,080
========== ===============
Shares were repurchased through the Company's stock repurchase
programs announced on July 12, 2005 and June 30, 2006, which permit the
repurchase of 34 million shares.
75
ITEM 6. EXHIBITS
Pursuant to the rules and regulations of the Securities and Exchange
Commission, the Company has filed certain agreements as exhibits to this
Quarterly Report on Form 10-Q. These agreements may contain representations
and warranties by the parties. These representations and warranties have
been made solely for the benefit of the other party or parties to such
agreements and (i) may have been qualified by disclosures made to such other
party or parties, (ii) were made only as of the date of such agreements or
such other date(s) as may be specified in such agreements and are subject to
more recent developments, which may not be fully reflected in the Company's
public disclosure, (iii) may reflect the allocation of risk among the
parties to such agreements and (iv) may apply materiality standards
different from what may be viewed as material to investors. Accordingly,
these representations and warranties may not describe the Company's actual
state of affairs at the date hereof and should not be relied upon.
2.1 Amended and Restated Agreement and Plan of Merger, dated as of
December 3, 2006, as amended and restated as of February 23,
2007, and as further amended and restated as of March 30, 2007,
between The Bank of New York Company, Inc., Mellon Financial
Corporation and The Bank of New York Mellon Corporation
(incorporated by reference to Annex A to Amendment No. 1 to the
Registration Statement on Form S-4 filed by The Bank of New York
Mellon Corporation with the SEC on April 2, 2007), incorporated
by reference to Exhibit 2.1 to the Company's Current Report on
Form 8-K as filed with the Commission on April 5, 2007.
3.1 The By-Laws of The Bank of New York Company, Inc. as amended
through April 12, 2005, incorporated by reference to Exhibit
3(ii) to the Company's Quarterly Report on Form 10-Q for the
quarter ended March 31, 2005.
3.2 Restated Certificate of Incorporation of The Bank of New York
Company, Inc. dated May 8, 2001, incorporated by reference
to Exhibit 4 to the Company's Registration Statement on
Form S-3 filed June 7, 2001 (File No. 333-62516, 333-62516-01,
333-62516-02, 333-62516-03 and 333-62516-04).
4 None of the outstanding instruments defining the rights of
holders of long-term debt of the Company represent long-term
debt in excess of 10% of the total assets of the Company. The
Company hereby agrees to furnish to the Commission, upon
request, a copy of any such instrument.
12 Ratio of Earnings to Fixed Charges for the Three Months Ended
March 31, 2007 and 2006.
31.1 Certification of Chairman and Chief Executive Officer pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of Chairman and Chief Executive Officer pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification of Chief Financial Officer pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.
76
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
THE BANK OF NEW YORK COMPANY, INC.
----------------------------------
(Registrant)
Date: May 9, 2007 By: /s/ Thomas J. Mastro
--------------------------------
Name: Thomas J. Mastro
Title: Comptroller
77
EXHIBIT INDEX
-------------
Exhibit Description
------- -----------
2.1 Amended and Restated Agreement and Plan of Merger, dated as of
December 3, 2006, as amended and restated as of February 23,
2007, and as further amended and restated as of March 30, 2007,
between The Bank of New York Company, Inc., Mellon Financial
Corporation and The Bank of New York Mellon Corporation
(incorporated by reference to Annex A to Amendment No. 1 to the
Registration Statement on Form S-4 filed by The Bank of New York
Mellon Corporation with the SEC on April 2, 2007), incorporated
by reference to Exhibit 2.1 to the Company's Current Report on
Form 8-K as filed with the Commission on April 5, 2007.
3.1 The By-Laws of The Bank of New York Company, Inc. as amended
through April 12, 2005, incorporated by reference to Exhibit
3(ii) to the Company's Quarterly Report on Form 10-Q for the
quarter ended March 31, 2005.
3.2 Restated Certificate of Incorporation of The Bank of New York
Company, Inc. dated May 8, 2001, incorporated by reference
to Exhibit 4 to the Company's Registration Statement on
Form S-3 filed June 7, 2001 (File No. 333-62516, 333-62516-01,
333-62516-02, 333-62516-03 and 333-62516-04).
4 None of the outstanding instruments defining the rights of
holders of long-term debt of the Company represent long-term
debt in excess of 10% of the total assets of the Company. The
Company hereby agrees to furnish to the Commission, upon
request, a copy of any such instrument.
12 Ratio of Earnings to Fixed Charges for the Three Months Ended
March 31, 2007 and 2006.
31.1 Certification of Chairman and Chief Executive Officer pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of Chairman and Chief Executive Officer pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification of Chief Financial Officer pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.